Fitch Ratings expects Indian banks to require over USD 200 billion in capital as growth picks up and banks progress towards Basel III. Indian banks' capital needs are likely to rise incrementally until the full phase-in of the Basel III regime in FY19 (financial year ending March). State-owned banks, which account for around 75% of system assets, will require the bulk of this new capital, as they suffer from lower capitalisation, high stressed assets2 and weak earnings.
Many state banks have announced plans to raise core equity in the near term; Fitch believes that AT1 capital is likely to have to bridge those capital needs because the banks' weak valuations would make it difficult for them to raise funds in the equity markets.
Investor appetite remains untested for AT1, which meets the largest share of the banks' capital requirements. The issuance of these loss-absorbing instruments has been restricted thus far to just three banks, and is confined to the domestic market. Amendments in September 2014 to make the instrument more creditor-friendly should help build investor interest, though the local market may not be able to completely fulfil the AT1 demand of banks. Involving retail investors also introduces a level of moral-hazard risks.
Fitch expects Indian banks' stressed assets to improve after FY15, but at a slow pace as the large inventory will take time to resolve. Progress will be led by improvement in the cyclical sectors, which (though leveraged) is likely to benefit from a sustained economic recovery. State-owned banks reported stressed assets of around 12% in FY14, versus around 4% of private banks and 10% for the banking system.
Some signs of asset-quality stability are beginning to emerge at certain large state-owned banks. Fitch expects the trend to gain strength as economic growth picks up pace-with India's real GDP growth projected at 5.5% in FY15 and 6.5% in FY16. That is against the backdrop of a new government with a clear electoral mandate and a renewed focus on policy reforms, which is likely to set the stage for a cyclical recovery.
Indian banks' infrastructure exposure remains a problem as the government's efforts at de-bottlenecking the various policy-related impediments have had a limited impact. Specialised project groups have tried to speed up the completion of various infrastructure projects [eg power], although second-order issues like fuel linkages may stand as operational roadblocks. Loan-loss expectation on these assets is low, but Fitch believes that resolving existing bottlenecks is a pre-requisite to revive interest in the sector.
Fitch believes that the large private banks are the best-positioned to capitalise on India's cyclical recovery- given the benefits of scale, low/moderate funding cost and adequate capital. State-owned banks' asset quality will also improve, but the impact will be limited to a large extent because of their higher exposure to structurally weak sectors, such as power; their large stock of stressed assets; and capital constraints. SBI and BOB appear relatively better positioned among the state banks to lead the recovery.
