Reserve Bank of India's (RBI) recent delay of Basel III implementation offers Indian banks' more time to meet the minimum capital requirements, Fitch Ratings says. This could particularly benefit some state-owned banks facing capital pressure.
The main benefit from the one-year moratorium will be the delay in the phase-in of the capital conservation buffer from end-March 2016 (FY16, which starts 1 April 2016), instead of FY15, as most other parameters remain the same. More importantly, banks would get some crucial breathing space from the lower 5.5% pre-specified capital trigger on additional Tier 1 (AT1) securities until FY19 when it reverts to 6.125%. The headroom of 0.625% will be particularly helpful for mid-sized state-owned banks where capital buffers are particularly challenged.
We believe RBI's actions are a tacit recognition of the potential difficulty state-owned banks would have faced in meeting full capital requirements under the previous timelines. State-owned banks still need the lion's share of the estimated total core capital requirement for the system, but have thus far largely relied on the government for new capital because of low internal capital generation and weak access to equity markets.
The RBI has also provided additional clarity on Basel III capital instruments and their behaviour, particularly on the issue of loss absorbency. The exclusion of temporary write-downs on Basel III capital instruments reinforces the regulator's intent to ensure capital securities act like equity when required under stress.
The flipside though is that greater loss absorbency would come at the cost of being less investor friendly. AT1 securities are expected to shoulder a large share of the capital burden and investor appetite is currently limited adding to the capital raising challenges.
From a ratings perspective, with permanent write-off now a standard feature across Basel III regulatory capital instruments, it is likely that Tier 2 subordinated debt will be notched twice from the relevant anchor rating because recovery prospects would be poor under a permanent and full write-down scenario. However, there would be no change to our stance on AT1 instruments, so notching for these would be unchanged.
