Recent losses incurred by United Bank of India (UBI) could see its capital ratios fall below the regulatory minimum, and test the authorities' approach to bank regulatory capital instruments in the present Basel III era, says Fitch Ratings. This is likely to be the first instance within Asia since the implementation of the Basel III framework. It is also important at this time because a number of Indian banks - mostly state-owned - are considering raising fresh regulatory capital in the international market, in light of the capital pressures on the sector.
The authorities face a dilemma, and their response could set a credit precedent. Existing holders of UBI's outstanding legacy basel II Tier 1 and Upper Tier 2 capital instruments will face the prospect of automatic coupon deferral as per Reserve Bank of India (RBI) regulations if the total capital ratio-which is currently borderline at 9%-were to be breached.
Moreover, compounding losses could exacerbate the risk for investors. This is because UBI's Tier 1 ratio was just 5.6% as of December 2013, below the Common Equity Tier 1 (CET1) trigger of 6.125% for Basel III Additional Tier 1 instruments and a 6.5% RBI minimum requirement from March 2014.
The RBI, like many other regulators, has not clearly defined the Point of Non-Viability (PONV) under Basel III. But should CET1 ratios for the banks fall further below 6.125%, the risk of reaching this point clearly increases. If these challenges persist, we would expect the RBI to allow capital ratios too fall further in an effort to find a resolution before triggering the PONV - which could include a fresh capital injection. The bank's main shareholder, the state, has (as part of its regular activities for state-owned banks) already injected capital amounting to Rs 7 billion this financial year.
A deferral of coupon payments on legacy Tier 1 and Upper Tier 2 instruments would be consistent with the overall approach agreed at the G20 level (of which India is a member): of ensuring that regulatory capital instruments behave more like equity at times when banks face difficulties, and thereby help in restoring an institution back to health. However, India has historically experienced a high level of support for problem banks-and few, if any, bondholders have experienced losses. "We expect this to continue for senior creditors of systemically important institutions, but this is less clear-cut for smaller institutions such as UBI-which has a market share of just 1.2% of total bank assets-and in particular for their junior instruments," it said.
Kolkata-based UBI's credit profile has weakened sharply, and has been worse than at other state-owned banks. Accelerating asset-quality problems raised its gross NPA ratio to 10.8% in December, up sharply from 5.6% in June, last year. This has weighed on performance, with a net loss of INR16.8bn in the nine months ended December 2013, against a INR3.6bn profit in the corresponding period the year before.
UBI was also the first state-owned bank in India to issue Tier 2 Basel III debt capital, through a Rs 5 billion private placement with the Life Insurance Corporation in June last year. The bank is reportedly undergoing a 'forensic audit' by the RBI to determine the causes of its underperformance, and there are restrictions on its ability to extend new credit.
Shares of the bank declined Rs 0.25, or 0.93%, to settle at Rs 26.55. The total volume of shares traded was 107,551 at the BSE (Tuesday).
