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The government’s Rs 2.11 lakh crore recapitalisation plan for public sector banks (PSB) comes at a crucial juncture i.e, when state-owned banks are fighting fire on three fronts: bad loans, declining profitability and thinning capital cushion compared with the regulatory requirement.
The recapitalisation will hopefully persuade banks to undertake a balance sheet clean-up, spend more time on growing their loan books which will improve profitability and enable them to meet the Basel III capital requirements.
What also helps is that the operating environment is getting better as reflected in CRISIL’s improving credit ratio and debt weighted credit ratio, which indicate that rating upgrades are outnumbering downgrades. CRISIL’s debt weighted coverage ratio has shown a significant improvement to 1.94% for the 12 months ended September 2017.
This indicates improving credit profiles of corporates, which are driven by higher commodity prices, lower interest rates, and improved capital structures. Consequently, overall stressed assets are unlikely to rise significantly from current levels.
In our view, stressed assets should not increase significantly over the medium term, but we expect gross NPAs to inch up to ~10.5 percent by March 2018 compared with 9.4 percent as of March 2017, due to slower pace of recoveries. As a result, credit profiles of PSBs should improve from here.
Meanwhile, CRISIL had estimated the capital requirement of PSBs at Rs 1.4-1.7 lakh crore by March 2019. That’s after considering the impact on bottomlines because of provisioning for non-performing assets (NPAs), and higher capital requirement under Basel III banking regulations.
In the past two fiscals, banks did save on some capital because credit growth was poor (so they didn’t need to set aside more capital for loans disbursed), and they also mopped up substantial funds (~Rs 30,000 crore in last fiscal) through Additional Tier 1 bond issuances. However, weak profitability more than offset this.
In our view, the proposed quantum of capital would be sufficient to deal with NPA issues that the PSBs are facing, and also leaves room for fresh credit creation.
We believe front-loading of capital will help PSBs advance the provisioning required for NPAs, meet the regulatory capital requirements, and, freed from these worries, focus more on bolstering their revenues.
PSBs have reported ~Rs 27,000 crore losses over the past two fiscals due to muted pre-provisioning profits (PPoP) and a sharp uptick in NPA provisions.
Weaker PPoPs had constrained the ability of banks to provide adequately for NPAs, which delayed meaningful progress on asset quality.
Now PSBs would be in a much better position to meet the regulatory capital requirement despite taking a hit because of higher provisioning. In our view, PSBs would be better off by front-loading provisioning (preferably in the current fiscal) on stressed accounts because that would help in a quicker clean-up of balance sheets.
While this would mean higher aggregate losses for the banking system – rising to ~Rs 60,000 crore this fiscal – it will leave banks with a reasonable provision cushion on stressed loans that, in turn, will reduce volatility in their profit and loss account, going ahead.
For the past three years, credit growth at PSBs has been wallowing in low single digits. That’s when asset quality challenges precipitated and the resultant need for higher regulatory capital started hurting. Investment activity in the economy has also been subdued, impacting corporate credit growth, which forms almost 50 percent of the total banking credit.
The government’s two-pronged approach of recapitalising PSBs and simultaneously announcing mega capex plans (such as in roads and highways) should set the stage for recovery in the credit cycle.
Retail credit continues to show traction and PSBs have improved their market share. After getting rid of the NPA baggage, and with more breathing space on regulatory capital, PSBs would be able to participate in the likely revival in credit cycle. That should eventually lift credit growth for PSBs closer to double digits.
The government’s recapitalisation programme reinstates CRISIL’s belief that the government will continue to provide strong support to PSBs, which gets centrally factored in our ratings.
By Krishnan Sitaraman, Senior Director - Financial Sector & Structured Finance Ratings, CRISIL Ratings