Capital needs have fallen from our previous estimate of USD90 billion, largely as a result of asset rationalisation and weaker-than-expected loan growth. Even so, state banks - which account for 95% of the estimated shortage - have limited options to raise the capital they still require. Prospects for internal capital generation are weak and low investor confidence impedes access to the equity capital market. Access to the Additional Tier 1 (AT1) capital market has improved in recent months - reflecting state support to help state banks avoid missing coupon payments - but around two-thirds of the capital shortage is in the form of common equity Tier 1 (CET1).
State banks are likely to be dependent on the state to meet core capital requirements. The government is committed to investing only another USD3 billion in fresh equity for 21 state banks over FY18 and FY19, having already provided most of the originally budgeted USD11 billion. Fitch believes the government will have to pump in more than double, even on a bare minimum basis (excluding buffers), if it is to raise loan growth, address weak provision cover, and aid in effective NPL resolution - the gross NPL ratio reached 9.7% in FY17, up from 7.8% in FY16.
The NPL resolution process being led by the Reserve Bank of India (RBI) could potentially release capital if recovery rates are as high as banks and the government are hoping for. There are 12 currently going through resolution, representing 25% of total system NPLs, and the RBI has recently released a list of 50 more accounts that banks have been directed to resolve within three months or push into the insolvency process.
Most banks do not expect haircuts to exceed 60%. However, those loss assumptions may look optimistic considering the first resolution of corporate debt under the government's new insolvency code produced a recovery rate of just 6%. Banks argue this cannot be extrapolated to the other exposures, which they say are backed by more productive assets. Nevertheless, average provision cover of 40%-50% is quite low considering that the accounts in question have been NPLs for two or more years and are financially stretched. Lower-than-expected recoveries are likely to put earnings at risk, and capital could be further undermined as a result.
State banks are unlikely to be freed from their current gridlock unless NPL resolution is accompanied by additional capital. They have already lost around 300bp in market share to private banks since FY12 as government capital injections have not been sufficient to support growth. Indeed, poor performance has led to a decline in the total CET1 capital of state banks over the last year, despite the injections. Indian banks' loan growth slumped to 4.4% in FY17 - the lowest in several decades - and it is unlikely that state banks will grow at all in the foreseeable future given their capital constraints. Many state banks, particularly smaller ones, will struggle to survive as individual banks, and could be swept up into the government's consolidation agenda.
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