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More than the Budget announcement, it took an action from the central bank to revive the markets. Equity markets ended on a negative note on the Budget day but have zoomed from the next day onwards. One might argue that the budget fine prints pushed the markets higher, while it might be partly true; the main kicker came from RBI’s guidelines.
On account of the deteriorating asset quality of banks the main concern for the sector was that these banks will not have enough capital left to protect themselves and grow in the future. Budgetary allocation of a paltry Rs 25,000 crore only added to the concern.
However, RBI provided the much sought after relief on capital for the banking sector. The RBI has come out with three amendments to include in Tier I, the revaluation reserve (at 55% discount), foreign currency translation reserve (at 25% discount) and Deferred Tax Assets (capped at 10%).
The timely review was carried out with a view to further aligning the definition of regulatory capital with the internationally adopted Basel-III capital standards, issued by the Basel Committee on Banking Supervision (BCBS). The amendments are applicable with immediate effect.
The move came as a surprise for the market as it was only factoring in cash inputs as capital in banks. Let’s try to understand the changes allowed by the central banker and why it brings relief to the sector, at least temporarily.
Revaluation Reserve is the amount added to the original acquired value of the asset in order to show its true value. Most of the banks, especially public sector ones are sitting on huge properties across the country bought at ridiculously low prices as compared to current land and real estate prices. Revaluation Reserve was allowed as a Tier-II capital by the central banker earlier. This has now been shifted to Tier-I in compliance with Basel-III guidelines.
According to an ICICI Direct report, Revaluation Reserve (RR) at industry level in bank’s balance sheet is around Rs 31,000-35,000 crore as on FY15. The 45% addition of revaluation reserve to Tier-I capital works out to around Rs 15,000 crore for these banks. The amount might look small, but SBI the largest bank along with other private sector banks do not have any revaluation reserve.
Reports say that revaluing its asset will add around Rs 20,000 crore to the revaluation reserve of SBI alone. Importantly, addition of this reserve in Tier-I give the banks more leverage to add to their Tier-II capital. Further, it delays the need for equity dilution for the banks and gives them room to absorb some more toxic assets. SBI had earlier spoken of raising around Rs 15,000 crore from the market.
As for foreign currency translation reserve (FCTR), which allows 25% of the reserve to be included in the Tier-I calculation is formed due to translation differences which arise as a result of translating the financial statement items from the functional currency into the presentational currency using the exchange rate at the balance sheet date, which differs from the rate in effect at the last measurement date of the respective item. Banks with foreign operations and exposures generally create this reserve. As per ICICI Direct total FCTR is around Rs 13,000-15,000 crore for the sector.
The third amendment is on deferred tax assets (DTA) which will be capped at 10% of the bank’s Tier I capital. DTAs arise due to timing difference (and not due to losses) which are presently deducted from Tier I capital at 60% and AT 1 (additional tier 1) capital at 40%. The value of reserve is similar to that of FCTR but smaller banks and larger private sector banks have higher such reserves.
Broking entity Jefferies in a report says that RBI’s rules will result in 0.4-0.8% increase in Tier I capital for public sector banks and 0.2-0.5% for private banks. On account of higher Tier I headroom will be created for AT1 and Tier II capital to the tune of 0.5-0.9% for public sector banks and 0.1-0.3% for private banks. SBI is reported as saying that its Tier I capital will increase by 100 basis points on account of these amendments.
The three amendments were announced at a time when banks disclosing higher losses in an effort to clean their books. RBI has awarded them by relaxing the rules, which are as per Basel III guidelines. Market too has rewarded banks as they will not need capital in the immediate future and can stay afloat for some more time, till they goof up again.
