The capital injection is part of a budgeted USD1.8bn allocation for banks in FY15, and will be credit positive for the nine recipient banks. The institutions included State Bank of India, Bank of Baroda and Punjab National Bank as well as six other smaller institutions. However, the capital shortfall and challenges for India's state banks will remain even after the injection. According to Fitch estimates, state banks account for 85% of the system's USD200bn Basel III capital needs up to 2019. This shortfall includes an estimate for the recently announced counter-cyclical capital buffer which will be phased in over the same period.
Furthermore, the ability to raise core equity Tier 1 (CET1) capital in the market is limited for many state banks, owing to below-book valuations alongside poor asset quality and earnings. Financial trends have been weak in the nine months ending December 2014. As a result, Fitch maintains that state-owned banks will have to continue relying on Additional Tier 1 (AT1) hybrid instruments and government capital injections to strengthen capitalisation in the short term.
The recent rise in issuance of AT1 capital by the various state-owned banks highlights this effort to build on their non-equity capital base, which adds up so far to less than 5% of the cumulative AT1 requirement for state-owned banks up until FY19.
It is notable, too, that the government announced new parameters to determine the allocation of the latest INR69.9bn capital injection, focusing on efficiency and earnings metrics including return on equity (ROE) and return on assets (ROA). All nine banks chosen by the government recorded above-average ROE and ROA for the time periods utilised for the capital allocation methodology.
India's private banks, in contrast, already maintain relatively healthy capitalisation levels. Healthier asset quality and earnings also mean that the larger private banks trade above book value and enjoy a level of investor confidence - the INR20bn (USD324m) domestic portion of HDFC's share sale was more than four times oversubscribed on 5 February.
HDFC is not the only private bank to have raised capital to finance growth over the medium term in the last few years. Strengthening capital positions at this time will better position several private banks to take advantage of a pick-up in economic growth in 2015. Fitch forecasts Indian real GDP to expand by 6.5% this year, up from an estimated 5.6% in 2014. State-run banks on the other hand, will likely have to sacrifice growth for some time - given their dependence on government capital.
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