Banks in no rush to tap equity mart

Prefer hybrid instruments to costly equity capital.

Banks need billions of rupees as capital this year to meet the new regulatory norms, but they are not in a tearing hurry to tap the equity market. This is despite the best of times for banks on the bourses.

"We will prefer to raise capital via upper Tier II and hybrid Tier I route as an equity issue will dilute the ROE (return on equity)," UTI Bank Chairman and Managing Director P J Nayak said.

The private sector banks would need a Rs 2,500 crore to Rs 3,000 crore boost to capital in the current financial year.

Banks may prefer to raise capital via hybrid instruments after Reserve Bank of India's approval because an equity issue would be costlier and could hurt the valuations of banks.

Post-Basel II implementation, banks' capital adequacy ratio is expected to fall by an average of 200 basis points.

Also, additional risk weights on real estate loans, additional provisioning on some standard assets, relentless credit growth, expansion plans, will erode banks' capital base.

Banks will need additional capital worth Rs 42,000 crore by 2010, Finance Minister P Chidambaram had said in May.

Several banks are now making a beeline to raise hybrid capital, albeit at a higher cost compared with other forms of loans taken by banks.

Hybrid capital will help banks to increase capital adequacy without additional stake dilution.

"Banks now have more options to raise capital. They can raise capital through upper Tier II, perpetual debt, subordinate debt. They (banks) will exhaust these options before coming up with an equity issue," said an analyst with a brokerage firm.

Currently, banks can raise up to 15 per cent of Tier I as hybrid capital.

The cost of equity capital is around 6 per cent more than the cost of raising debt, analysts said.

Cost of equity capital is the total of market risk premium and 10-year government security. Currently, market risk premium is around 6 to 7 per cent and 10-year government security is 8.09 per cent.

Market risk premium is the premium that investors are willing to pay on a stock compared with assured return on government bonds.

In a hardening interest rate regime, the differential between the cost of raising equity and debt is narrowing, with debt becoming costlier.

From end-March till date, the 10-year government bond yield has gone up by around 1.60 per cent.

ICICI Bank has raised perpetual debt at 10.1 per cent with a step-up option of 11.1 per cent at the end of the tenth year. Oriental Bank of Commerce, Bank of India, Syndicate Bank raised upper Tier II at around 9.35 per cent.

However, despite rising yields, debt is still cheaper than equity. "Nobody wants to dilute ROE. After one year, the earnings will be higher and the ROE will also be higher," said Vishal Goyal, analyst with Edelweiss Securities.