The new Basel III norms, which are to be implemented from January 1, 2013, should render the global banking system much less vulnerable. But their implementation starts at a time when Indian banking is under stress. Public sector banks (PSBs), which hold roughly 70 per cent of all assets, are in especially poor shape. There is provision for Rs 15,000 crore of PSB equity infusion in the 2012-13 Budget. But given decelerating growth and a big fiscal deficit, the government will struggle to recapitalise PSBs. The sector will have to raise huge sums in multiple stages as well as structured combinations of various types of debt and equity to comply with Basel III by the March 31, 2018 deadline. The capital adequacy ratio (CAR) for risk-weighted assets (RWA) has been raised to 10.5 per cent from eight per cent. Tier I capital has been hiked to six per cent of RWA from four per cent. The minimum equity to RWA ratio has been raised to 4.5 per cent from two per cent. Starting January 2015, banks must also hold a capital conservation buffer of 2.5 per cent of RWA.
The next five years will, therefore, see a lot of bank paper hitting equity and bond markets. The Reserve Bank of India estimates that, given annual RWA growth rates of 20 per cent and about 1.2 per cent of RWA per annum in internal accruals, PSBs will require equity infusions of Rs 1.5 lakh crore by 2018. PSBs will also need Rs 2.65 lakh crore in non-equity capital. Private sector banks will need Rs 25,000 crore of equity and Rs 50,000 crore of non-equity. In order to maintain PSB shareholdings at the current level of 59 per cent, the government will have to pump in Rs 90,000 crore of equity. For comparison, the government infused Rs 12,000 crore into PSB equity in 2011-12. Apart from that, all banks (PSB plus private) between them raised only Rs 52,000 crore in equity since 2007-08.
It will not be easy to whip up enthusiasm for PSB public offers or rights issues. Their balance sheets are unattractive and, in some cases, fragile, with deteriorating asset quality and under-provisioning. Several PSBs have made no provision for non-performing loans running at above 100 per cent of book value. About 28 to 30 per cent of corporate loans are to borrowers with interest coverage ratios lower than one. Private sector banks have better asset quality. This finds reflection in their market valuations about four times as high as those of PSBs. But their needs are also significant. As and when there’s a macroeconomic rebound, non-performing loans will decline, easing some pressure. It will also be easier to raise capital. But advances will also increase as growth picks up. The credit-to-GDP ratio is at a modest 55 per cent and likely to jump if GDP growth lifts by 150 to 200 basis points. As advances increase, so will the need for capital. The banking sector is all set to see a delicate balancing act playing out over the next five years.