But minimum common equity of 7% may hit return on equity
Most Indian banks are sufficiently capitalised and unlikely to need additional capital in the near term to meet the Basel-III norms approved by the Basel Committee on Banking Supervision (BCBS) on Sunday. But emphasis on core capital and a conservation buffer could put pressure on banks’ return on equity, said some analysts.
BCBS recommended that Tier-I capital, which includes common equity and other financial instruments, will have to be increased to six per cent from four per cent. It suggested raising the minimum common equity capital requirement from two per cent to 4.5 per cent by January 1, 2015.
As on June 30, 2010, the aggregate capital to risk weighted assets ratio of the Indian banking system stood at 13.4 per cent, of which Tier-I capital was 9.3 per cent, according to the Reserve Bank of India (RBI) data.
This is well above the six per cent Tier-I capital ratio mandated in the Basel-III norms. However, the standards mandate a minimum common equity of seven per cent, including a capital conservation buffer of 2.5 per cent. This may be a challenge, especially for public sector banks, which rely more on perpetual debt instruments to shore up their Tier-I capital, say analysts.
The conservation buffer is intended to achieve, what BCBS says, “The broader macro-prudential goal of protecting the banking sector from periods of excess aggregate credit growth.”
“There is no significant impact on Indian banks at this point in time. Current capitalization of top banks in India won’t require them to increase core capital significantly,’’ said Vibha Batra, co-head for Financial Sector Ratings at ICRA Ltd. “Although some public sector banks —which have the government support in the form of preferential shares for non-core Tier-1 capital — may need to strengthen their core capital.’’
“At present, public sector banks have a larger component of perpetual debt (and hence higher leverage) and lower Tier-1 ratios in general compared to private sector banks. Hence, a quicker transition to Basel-III will impose relatively greater capital requirements on them if they have to maintain current levels of growth,” according to a note from Macquarie Equities Research.
Bank of India and Union Bank of India have the lowest core Tier-1 ratios (less than 7.5 per cent). The core Tier-1 ratio of private sector banks is 13 per cent-plus on an average. The new norms will be implemented between January 1, 2013, and January 1, 2015. The Bankex was up 3.62 per cent to close at 1,3454.56 points. One of the biggest gainers was the country’s largest lender, State Bank of India, which rose 5.5 per cent to '3,147.25, a record high. ICICI Bank rose 4.4 per cent to '1,097.30.
Return on Equity
Analysts say the proposed norms may pose a challenge to growth and sustainable return on equity over the longer term as leverage reduces. “A higher core Tier-1 ratio, coupled with a conservation buffer of 250 basis points, could impact growth. It could result in lower leverage, implying lower sustainable return on equity” Macquarie group said in a research note. “The new common equity norms will place premium on efficient use of capital,’’ said Monish Shah, senior director with Deloitte Consulting. “It will make banks risk sensitive and realign exposure for better use of capital.’’
“Most Indian banks have a minimum core Tier-I ratio of seven per cent, so banks are comfortable on that count,” said a senior executive of the country’s third largest lender, Axis Bank. “What we are more concerned about is the liquidity standards.’’
The Basel-III norms involve two regulatory standards for managing liquidity risk — a liquidity coverage ratio to ensure resilience over the short term and a net stable funding ratio to promote resilience over the longer term. “The major challenge for Indian banks lies in implementing the liquidity standards as they have limited capability to collect the relevant data accurately and granularly, and to formulate and predict the liquidity stress scenarios,” RBI Governor D Subbarao had said in a speech in Mumbai last week before the Basel-III norms were finalised.
