Equity-raising by Indian banks in the last couple of months is the first step in the sector's transition towards Basel III requirements, Fitch Ratings says. As the sector enters the phase of transitioning into the Basel III-based capital regime (April 2013- March 2018), the banks need stronger access to the capital market to support growth and to meet the higher capital requirements being phased in. New investor-friendly reforms could support this if these trends continue.
The fresh capital raised by private banks should fund credit growth and give the banks an early start in meeting the Basel III requirements. IndusInd Bank issued INR20bn in December 2012, improving its Tier 1 ratio to 14.85% at end-2012 (including nine months of profit). Axis Bank boosted its equity base by 20% through an INR55bn capital placement in January 2013.
The banking system needs a strategy to achieve Basel III compliance - despite the transitional requirements being largely back-loaded, with over three-quarters of the additional regulatory core capital arising in 2016-2018. The Reserve Bank of India estimated additional capital requirements for private banks to be INR200bn-250bn (USD3.6bn-4.6bn). For the state banks, the estimate of the government's share is INR880bn-910bn (USD16bn), assuming public ownership is maintained at current levels, of which INR125bn (USD2.3bn) was injected into 10 public sector banks in January. The capital position for state-owned banks is underpinned by the government's commitment to maintain a minimum 8% Tier 1 ratio.
The government now has an additional source of funding for the banks, as amendments made in January 2013 allow the National Investment Fund to use proceeds from disinvestments. For the year-ending March 2013, INR300bn (USD5.5bn) of divestments are targeted. But the government banks still need to access the capital markets to source their remaining Basel III needs (INR520bn-590bn (USD9.6bn-10.8bn), according to the RBI) from private investors, and would need to start preparations for this.
Private banks with better credit metrics are likely to find it easier to access equity capital markets. But changes to the competitive landscape from the much-anticipated issuance of new banking licences could increase demand for capital.
Raising private equity could prove challenging for state-owned banks, as they typically have weaker internal capital generation than their private peers. Those with weak asset quality and funding profiles are likely to be the most constrained.
The Banking Laws (Amendment) Bill 2012 could help to attract the necessary investment. The cap on voting rights of a shareholder has increased to 26% from 10% for private banks, and to 10% from 1% for government banks. The sector could see greater investor interest if this trend to increase private participation continues. But foreign banks are unlikely to be willing to hold significant minority stakes given the punitive capital-deduction requirements under Basel III for holding investments greater than 10% in other financial institutions.
The bank reforms also relaxed the rules for public sector banks to access capital markets, allowing for the issuance of preference shares and rights or bonus share issues. The ability to raise capital through various means could help the banks with the transition to Basel III.