Srikanth Vadlamani, VP - Senior Credit Officer, Financial Institutions Group, Moody's Investors Service Singapore Pte. Ltd.
On 7 February, the Indian government announced that it will inject INR69.9 billion of capital into nine state-owned banks, the first portion of the INR112 billion that the government has earmarked for that purpose in the fiscal year ending 31 March. Importantly, the government also changed the criteria for this fiscal year's allocation, using banks' profitability as a key parameter.This change is credit negative for state-owned banks that are less profitable, including Central Bank of India (Baa3 negative, E+/b3 negative ), Indian Overseas Bank (Baa3 stable, E+/b2 stable) and IDBI Bank (Baa3 stable, D-/ba3 negative). However, Punjab National Bank (Baa3 stable, D-/ba3 stable), Bank of Baroda (Baa3 stable, D/ba2 negative), State Bank of India (Baa3 stable, D+/ba1 negative) and Syndicate Bank (Baa3 stable, D/ba2 negative) would benefit because they among the more profitable state-owned banks.
Banks will receive capital based on their relative efficiency. This means that the government will only consider allocating capital to banks whose average return on assets over the past three years and whose return on equity over the past one year are higher than the corresponding weighted average ratios of state-owned banks overall. This marks a significant change from the criteria the government has used for past capital allocations. Over the past three years, banks with weaker capital levels received larger capital allocations, regardless of their size or profitability.
Under these new criteria, weaker state-owned banks with low capital levels and less ability to generate capital internally will have to rely on external capital infusions. This will be challenging given that even strong state-owned banks have found it difficult to access the equity capital markets. Thus, capital infusions from the government are currently the only way for these banks to improve their capital ratios. If the government were to scale back capital allocation to less profitable banks, as the new policy suggests it will, it would have significant negative implications for their capital ratios.
The new policy will benefit more profitable state-owned banks because they may now get a higher amount of capital than they previously expected. However, even after these capital infusions, the capital levels of these relatively more profitable banks will remain weak. For instance, the current round would increase the Tier 1 ratios of the five rated banks receiving capital by only 17-36 basis points. Unless the government materially increases the capital allocation to state-owned banks in the next budget, the only way these banks can improve their capital ratios is by accessing equity capital markets.
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