Srikanth Vadlamani, Vice President - Senior Analyst, Moody's Investors Service
On 27 March, the Reserve Bank of India (RBI) announced revisions to its Basel III capital regulations timeline, including delaying the phase-in of a higher capital threshold. The delay is credit negative for public-sector banks because it allows the banks to operate at relatively low levels of capital when undercapitalization is one of the key weaknesses of Indian banks.RBI made two key changes to its existing Basel III capital regulations implementation schedule. First, the implementation of a capital conservation buffer (CCB) will now start in March 2016, a year later than the central bank originally planned. Correspondingly, full implementation of Basel III capital norms, including CCB, will take place in March 2019 instead of March 2018. Second, transitional arrangements for minimum capital conservation ratios (MCCR) have also been delayed one year.
The capital regulations timeline changes aim to ease the capital requirements of public-sector banks, which are already low considering their asset quality challenges and their relatively low provision coverage levels. In addition, public-sector banks' internal capital generation is low because of structurally low profitability and elevated credit costs. As such, these banks rely on external capital infusions, primarily from the Indian government, to meet their capital requirements including Basel III requirements. The revised rules mean that capital at these banks will remain lower than they otherwise would have. Among the Indian banks we rate, Union Bank of India (Baa3 stable, D/ba2 negative) and Central Bank of India (Baa3 negative, E+/b3 negative) have the lowest Tier 1 ratio.
Separately, the RBI changed the pre-specified trigger for the activation of loss-absorption option for so-called point of non-viability (PONV) securities eligible for additional Tier 1 (AT1). The new trigger upon which bondholders will absorb losses is a common equity Tier 1 ratio (CET1) of lower than 5.5%, down from 6.125% previously. However, this lower CET1 trigger will apply only until March 2019, when it will return to 6.125%. Furthermore, all non-equity capital instruments now have only a conversion and/or permanent write-down features, owing to the RBI having removed the option of having a temporary write-down feature.
We see the changes in the loss-absorption features of non-equity capital instruments as having a mixed credit effect. A lower pre-specified trigger slightly reduces the probability of a trigger event and thus reduces the probability of the write-down or the conversion feature being exercised. However, the removal of a temporary write-down feature increases credit risk because a security written down cannot be written back even if the bank's financial condition improves. So far, there has been no issuance of AT1 instruments from Indian banks, and we expect the bulk of the external capital requirements over the next 12-18 months to be met by government capital injections.
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