For banks, we see limited credit effect because the measures do not address the more pressing issue of banks' capital weakness

Srikanth Vadlamani, VP - Senior Analyst and Gene Fang, VP - Senior Credit Officer, Financial Institutions Group, Moody's Investors Service Singapore

For Banks, Credit-Positive Elements, but Capital Strains Are Unaddressed:

The budget has only a limited credit effect on Indian banks because it does not address their immediate challenges, especially the challenge of capitalization.

The budget fails to increase the INR112 billion that the previous government committed to recapitalizing public-sector banks for fiscal 2015 (ending March 2015). The INR112 billion amount, which is lower than that of fiscal 2014, falls short of these banks' high capital requirements. The banks need capital to support low- to mid-double-digit loan growth, comply with Basel 3 regulations and improve their loan loss coverage levels. The modest capital injection poses the risk that the banks will operate with thinner capital buffers than in fiscal 2013.

 

Besides the issue of direct capital injections, some budgetary measures were announced to facilitate the recapitalization of the banks, but we do not believe they will bring real benefits until 2015 or later.

Government shareholding reduction. The new administration's pledge to reduce the government's stake in public-sector banks to no more than 51%, from the current 56%-89%, would eventually give the banks greater flexibility to raise capital from the equity market. However, this measure is unlikely to have any meaningful effect in the near term. This is because the key constraint on public-sector banks' external capital raising has been their inability to attract fresh private capital, rather than a lack of willingness on the part of the government to reduce its stakes. It remains to be seen whether investors' appetite for Indian public-sector bank equity has increased, which is something the budget has little to no ability to influence.

Proposal to allow increased foreign direct investment and controlling shareholding in insurance companies. Banks with meaningful insurance operations like ICICI Bank Limited (Baa3 stable, D+/baa3 stable) and State Bank of India (Baa3 stable, D+/ba1 negative) may benefit from the proposed increase in the foreign direct investment limit in the insurance sector, which will provide them with the opportunity to raise capital by selling stakes in their insurance subsidiaries to their foreign joint venture partners. The budget proposed increasing this limit to 49% from the current 26%. Such transactions take considerable time to execute and, most importantly, few public-sector banks other than SBI have substantial insurance operations.

The government also indicated that it wants public-sector banks to have increased autonomy with respect to their governance and strategic direction, and signalled it would support consolidation. Although this is a constructive shift in policy to address the banks' governance issues, details are lacking on how this may be implemented.

Nevertheless, some targeted measures in the budget are outright, although modest, credit positives for banks:

The budget promises some funding relief to the real estate and infrastructure sectors, which may also help improve their loan performance. Specifically, the government will allow banks to raise long-term funds for lending to infrastructure projects, and exempt such funds from reserve requirements.

It has also proposed incentives to attract long-term funds into real estate investment trusts (REIT) and infrastructure investment trusts, which is a modified REIT type structure for infrastructure projects. The infrastructure sector is currently one of the key sources of asset quality stress for Indian banks, so improvements in that sector's financing are likely to also help banks' asset performance.

Banks could see faster resolution of their bad loans from the proposed creation of six new debt-recovery tribunals. This is credit positive since the current lack of capacity at existing tribunals has been one of the factors hampering banks' debt recovery efforts.

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