Ind-Ra: Capital Support Increasingly Critical for Banks; Credit Costs to Erode Profits in FY17

India Ratings and Research (Ind-Ra) has maintained a stable rating and sector outlook on private sector banks and a stable to negative sector outlook for public sector banks (PSBs) for FY17. Capital requirements towards Basel III transition continued to increase in FY16, despite INR700bn as announced under the Indradhanush plan. Ind-Ra will watch out for any addition capital infusion announcement in the forthcoming union budget. The agency expects large private banks and the some large PSBs to be better placed with healthy internal accruals, strong capitalisation and better access to the capital markets. Most PSBs are likely to be under pressure to consolidate growth and focus on profitability given their significant capital requirements both from government and capital markets. Ind-Ra has also assigned a stable outlook to small finance banks.

Ind-Ra estimates the incremental tier-1capital requirement to be INR2.9trn till FY19; which includes INR1.5trn in Additional Tier I (AT1) bonds. Critically, at least INR550bn in AT1 bonds would be needed by March 2017, given the current growth plans. So far banks have raised INR130bn through AT1 bonds from the market, active participation by insurance companies and provident funds however remains to be seen. Hence, a pick-up in AT1 appetite remains a key monitorable in FY17.

 

Ind-Ra also expects credit costs to increase sharply in FY16E and FY17, given the persistent stress from large levered corporates and increasing recognition of the stress by the banking system. Impaired assets are expected to rise to 12.5% of loans by FY17 (including gross non-performing loans, standard restructured assets and asset reconstruction company receipts) compared to 10.8% in FY15. As highlighted in Ind-Ra's report 'The INR1trn Shortfall from Distressed Corporates', the agency estimates 1.7% of risk weighted assets as the potential haircut needed by banks to bring a bulk of the corporate exposure to a viable leverage level. However, credit growth is likely to get some support from the macro tailwinds going into FY17. Consequently, the agency expects the banking system's return on assets to dip in FY16 and then marginally rise in FY17.

Private sector banks continue to improve their funding profile, on the back of their growing market share in current and savings account deposits. Conversely, most PSBs continue to report high funding gaps and may see a negative impact on their margins from increasing requirements on liquidity coverage ratio and the guidelines relating to the marginal cost of funding based lending rate.

Ind-Ra also expects the small finance bank and payment banks to lead the change in the banking landscape, by cornering increasing share of small ticket transactions and gaining market share in both granular liabilities and well as retail assets.

OUTLOOK SENSITIVITIES

Long-Term Issuer Ratings for PSBs are largely support driven and will change only if there is any change in the government's support stance or a relative shift in their systemic importance.

Ratings for private sector banks and ratings on tier-1 bonds (like AT1) for all banks are linked to the respective banks' standalone profile. Positive triggers such as improvements in funding gaps and single-name concentrations together with increased capitalisation levels and lower loan loss provisions may result in a positive outlook for banks whose ratings are driven by performance.

Negative triggers will be pressure on capital ratios due to weak profitability, a spike in credit costs and delays in equity injections may lead to a negative sector outlook. Issuer ratings of government banks will mostly remain resilient on the expectations of continued government support.

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