Is SBI's Tier-I capital really low?

The downgrading of State Bank of India by Moody's, an international credit rating agency, is not because its Tier I capital is lower than the minimum stipulated by the RBI, but largely due to the Government of India (GoI) not fulfilling its own commitment.

Recognising this, the government has recently decided to infuse Rs 8,500 crore in the form of capital, as reported recently in this paper. To state a fact, SBI's Tier I capital, at 7.6 per cent, is higher than the regulatory requirements, either in India or anywhere else on the globe. The important issues are discussed in this article.

Regulations regarding the capital of commercial banks emanated from what are known as the Basel rules. These were laid down approximately two decades ago by the Bank for International Settlements (BIS), based in Basel. BIS is a club of the top central banks. Till then, there were no rules regarding the minimum level of capital of banks in relation to their assets (and consequently, borrowings through deposits or otherwise).

When a new category, Tier II capital, was created, it consisted primarily of long-term loans that were contractually subordinated to deposits. The level was placed at 8 per cent as capital funds (CF), comprising Tier I (shareholders' funds) and Tier II.

CAPITAL FUNDS

The Reserve Bank of India adopted these rules in 1992. Later, the RBI tightened the level to 9 per cent of CF for banks operating in India, against the international norm of 8 per cent. The RBI further laid down that banks should set apart from profits, 70 per cent of all Non-Performing Assets (NPAs), irrespective of the level of security held against them.

Thus, if a loan is secured by valuable property worth more than 90 per cent (potential loss 10 per cent), even then, in the bank's books, it will be valued only at 30 per cent. Both these unique rules make the banks in India financially stronger than those in other countries.

BIS modified the norms in 2006 (called Basel II), and the RBI has adopted them, with some changes, but retaining the higher level of 9 per cent for CF. Despite the prudential level of 8 per cent for CF, many large international banks in the West faced bankruptcy after 2008, because of a rule in the Basel norms. Chastened by the recent financial meltdown, all major central banks are in the process of evolving higher capital requirements and even some minimum liquidity to meet emergent circumstances. Only now, it is contemplated that there should be a minimum level of Tier I capital.

The proposal is to have at least 4.5 per cent as Tier I capital, and an additional capital conservation buffer of 2.5 per cent, with a total of 7 per cent. It is yet to be implemented. SBI's Tier I capital is above this level also. Compared to SBI's level, the average of banks in Eurozone is 4.7 per cent, in UK 4.63 per cent, Japan 4.70 per cent and China 5.63 per cent; only in US, the average of major banks is 7.87 per cent, as per a study of top 1000 global banks.

MINIMUM CAPITAL

Even before BIS thought of minimum Tier I capital, the RBI had stipulated that banks in India should have Tier I capital equivalent to two-thirds of total capital funds, or 6 per cent. SBI's level is well above this limit. In spite of all these facts, Moody's latched on to the budget speech of the Union Finance Minister in 2010, when he said, inter alia , that: “For the year 2010-11, I propose to provide a sum of Rs 16,500 crore to ensure that the public sector banks are able to attain a minimum 8 per cent Tier I capital by March 2011.”

For Finance Ministry babus, such commitments are not sacrosanct, and they weren't monitoring the situation vis-à-vis SBI. It is a different matter that, for them, even guarantees given by the Government are not binding and are rarely met on time and in full.

To shore up capital in time, SBI has been pleading with the Government, in vain, to contribute its share. Taking cognisance of this, Moody's reportedly commented that SBI's efforts to secure this capital for the better part of the year demonstrates the bank's limited ability to manage its capital.

SBI was, till recently, majority-owned by the RBI, and the Government took over the ownership a few years ago. Had the RBI continued to own, SBI might have raised the required capital well in time. Only now, Government mandarins have woken up and have promised to give additional capital of Rs 8,500 crore to SBI. With this, SBI should comfortably meet the Government's goal of 8 per cent Tier I capital, for public sector banks.

To conclude, SBI continues to be a well-capitalised bank based on regulatory requirement, but needs to augment capital for expansion because the portfolio of non-performing assets of the banking system might grow due to recessionary conditions faced by the industry and business. And, government officials should take prompt action with regard to nationalised banks' capital needs, as they are the bedrock of our financial system.

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