Bank recapitalisation: Rating downgrades arrested but upgrade is long haul

Focus shifts to board governance, performance improvement. Rethink on public offering in Fy18

The capital injection and steps for improving governance for public sector banks may have arrested downgrading of rating and outlook. But it will take a while for upgrades as that hinges on improvement in performance, governance and credit profile.  

Now the focus shifts to the execution of turnaround plan, especially for those banks that are under Prompt Corrective Action (PCA) plan under Reserve Bank of India supervision. The onus on accountability falls on directors as new metrics put pressure on banks and their boards to perform so that a similar crisis does not repeat.

Also, with sizable chunk of capital to come into kitty, those thinking of visiting market to raise equity through public offering in fourth quarter may push activity to next finance year. The hope is that the resolution of big ticket bad loans and uptick in operational performance should improve profile and fetch better valuations.

Executives with Mumbai-based Bank of India said the operational improvement and significant government capital commitment, bank is better placed to meet regulatory norms. So, with just two month remaining in FY18 bank not visit the capital market to raise equity in the current quarter.  

Rating agencies said front-loading of capital in excess of Rs 800 billion to meet regulatory capital norms and provision for supporting growth and emphasis on performance improvement is credit positive. At present many PSBs have a negative outlook on their various instruments.

Srikanth Vadlamani, Vice President and Senior Credit Officer at Moody’s said this announcement is a credit positive for all public sector banks, and especially the weaker ones. This is so as the government has made clear that it will ensure that all such banks meet minimum regulatory capital requirements.

Krishnan Sitharam, Senior Director, CRISIL Ratings, Indian subsidiary of Standard and Poors’ (S&P) said the recapitalisation plan is credit positive and the terms and conditions (for performance) and monitoring are expected to bring in more discipline in conducting business.

Global rating agency Fitch said it should help in part to mitigate the risks that Indian state banks face on account of weak asset quality and poor earnings. However, unwinding of these risks will take some time.

The resolution of bad assets and continued high credit costs will hinder the sector's near-term performance. The agency maintains its negative sector outlook to reflect these pressures, Fitch added.

Emphasis on turnaround, board governance

Vadlamni of Moody’s said the government also announced various reforms for PSBs. But these reforms are not meaningful enough to address the structural corporate governance issues facing these entities.

Among measures to reform, the most important ones relate to board governance and corporate loans. For instance, under the new rules, the board of each bank must monitor the institution's performance in key metrics more frequently. Also, banks must implement performance management systems to incentivise strong performers.

The new rules will also require banks to more closely monitor corporate exposures larger than a certain size. These additional requirements are positive. But they are not enough to address banks' fundamental weaknesses as new rules will largely only tighten existing core internal processes, rather than structurally improve governance.

PSB's governance issues include a misalignment of incentive structures; labor force rigidity; a lack of continuity in senior management and succession planning; and varied, and sometimes conflicting, business objectives.

No early to exit from PCA framework

The recapitalisation will help banks especially those under Prompt Corrective Action (PCA) to reduce the Net NPAs as well as improve capital ratios.  However, as many PSBs are likely to continue reporting losses during FY2018 due to elevated provisioning levels. They are likely to remain under PCA based on FY2018 financials, till they return back to path of profitability.

At present, 11 out of 21 public sector banks under PCA framework specified by Reserve Bank of India (RBI) due to their high NPA levels as well as consecutive years of losses.