The equity injection plan is in line with Ind-Ra's support expectation and justifies the Stable Outlook and through-the-cycle rating approach for senior debt of government banks. The support floor provides rating stability and shields long-term debt holders from the effects of cyclical performance volatility. The impact may be more marked on holders of additional Tier 1 debt. This debt is meant to absorb the effects of short-term performance downturns. Ind-Ra's criterion for AT1 bonds provides a transparent tool for comparing the relative riskiness of this instrument issued by various banks.
The capital infusion framework outlined by the government is based on the size of banks and on CET-1 ratios and ends the uncertainty around the government's contribution. However, banks will need to raise an additional INR150bn from the equity market together with INR400bn AT1 bonds during the year. In addition, Ind-Ra's research suggests a provisioning gap due to overleverage in distressed corporates, which may need to be filled in by equity. Improvement in efficiency will be key to banks being able to raise funds from the equity market.
The formation of the Bank Board Bureau in-line with the Nayak committee recommendation, will lead to delinking bureaucracy from governance. The bank bureau can make a difference by providing greater autonomy to bank boards and longer tenures for PSU bank chiefs. Public sector banks chiefs on an average have had tenures of three years compared with ten-year-long tenures of private peers. This has led to the lack of a long-term vision.
Regarding de-stressing banks' balance sheets, the government hasn't adequately addressed the problems of rising bad loans in the system. Indian banks may need up to INR1trn over and above their Basel-III capital requirements to manage the concentration risks arising out of their exposure to highly levered, large stressed corporates, believes Ind-Ra. Of this, public sector banks will need INR930bn, which is equivalent to an equity write-down of about 1.7% of the banks' risk weighted assets, and represents the loan haircut that banks may face to revive the financial viability of distressed accounts.
The incentive structure laid down is a long-term positive for the performance of PSU banks and is a step in the right direction. ESOPs and the performance linked pay structure will lead to improved efficiencies in the long term.
Finally, the need to raise funds from the equity market remains, despite the planned capital infusion by the government and it is therefore imperative for government banks to improve performance and market valuations. Also the lack of importance given by the government to asset quality will mean that we may not see much improvement in asset quality stress for PSU banks.
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