Ind-Ra: SCBs May Need INR890 billion Provisioning under Ind-AS

Scheduled commercial banks (SCBs) may need up to INR890 billion towards incremental provisioning for advances while transiting to the Ind-AS 109 regime, says India Ratings and Research (Ind-Ra). Of this, public sector banks (PSBs) would need INR631 billion, which is equivalent to an equity write-down of 1.10% of the banks' risk weighted assets and 11.5% of net worth at end-March 2017. Private sector banks would also need a whopping INR258 billion; however, their higher capitalisation would enable a smooth transition.

The provisioning required for migration to Ind-AS along with asset quality overhang and Basel III transition would surge capital consumption by banks especially PSBs. Ind-Ra, however, believes that staggering the provisioning requirement for the migration to Ind-AS 109 could reduce the intensity of the potential impact.

 

Assumptions: The agency's study assumes a lifetime probability of default (PD - accounts with payments overdue post 90 days) of 15% (exceeding the current regulatory requirement of 0.4% for majority of assets in SMA2 categories) and 100% for stage 2 and stage 3 assets, respectively. Also, Ind-Ra estimates a possible blended haircut of around 50% across stressed assets. The current study assumes a loss given default (LGD) of 50% for all assets across stage 2 and stage 3. The agency's calculation of restructured assets (2.5% of gross advances as of September 2017) include all categories of standard restructured assets including 5/25, S4A and SDR. The study includes the additional provision requirement in stage 2 on account of SMA2 exposure (last 30 months average) across the banking sector and additional provisioning on account of standard restructured advances in stage 3.

Additional provisioning requirement assumes 15% provisioning already set aside by banks. This is on account of banks providing higher for select standard restructured assets post the Reserve Bank of India's asset quality review and annual divergence exercise. The agency excludes the provisioning requirement on non-performing assets (NPA) exposure which form a part of stage 3 assets, given the current (as of September 2017) provision on NPAs is close to 50% which is the expected LGD across sectors.

Provisions to Follow a Steep Curve: Ind-Ra assesses the provisioning requirement for stage 2 assets to be significantly higher at 7.5% of gross advances than 0.4% under existing Indian GAAP accounting for most of the assets in the SMA2 category. The regulatory requirement of provisions on standard restructured assets (stage 3 assets) is set at a minimum of 5% which again maps significantly lower than what is anticipated under the new regime. Ind-Ra believes a significant increase in provisioning in the new regime may necessitate reduction in risk weights in select asset categories to make a judicious balance between the existing and Ind-AS framework.

Headwinds under Ind-AS to Knock Down Growth Aspirations: In October 2017, the government of India announced a direct recapitalisation of INR1.53 trillion (INR1.35trillion through recapitalisation bonds and INR0.18 trillion as a part of Indradhanush framework) in PSBs. Assuming Ind-AS is implemented from 1 April 2018, close to 41% of announced recapitalisation funds would be consumed towards incremental provisioning requirements, putting pressure on PSB's ability to meet the regulatory core equity tier 1 capital under Basel III framework. This could increase the pace of portfolio churn and credit market shift towards private sector banks, and partly towards wholesale non-banking finance companies. PSBs' loan growth increased to 8% yoy at end-September 2017. Additionally, Ind-Ra believes PSBs' capital consumption to remain high, given that profit and loss accounts (P&L) for most of banks (especially mid-size PSBs) would remain under pressure due to the accelerated provisioning requirement on the accounts identified by the regulator for reference to the National Company Law Tribunal under the Insolvency and Bankruptcy Code in FY18.

As per Ind-Ra's estimates, the quantum of the government's proposed capital injection in PSBs, together with the banks' proposed mobilisation of capital, should largely cover the provisioning shortfall for their stressed assets. The capital can also support modest growth (around 7%) in advances. Ind-Ra estimates additional equity would be required if the credit demand were to pick up, though it does not form the base case scenario in view of the large idle capacity in the system.

APAC Scenario: As per a survey conducted by Fitch Rating Ltd, only Chinese banks listed in Hong Kong are likely to implement IFRS 9 in 2018, whereas Thailand aims to implement in 2019, Indonesia and Mongolia are targeting 2019-2020.

Impact on Ratings: Ind-Ra's outlook towards the standalone profile of PSBs (especially mid-size) remains negative due to the possible additional provisioning burden that could surge their capital requirements. The impact on large PSBs and private sector banks remains limited, given their better capitalisation levels and superior ability (better market valuation) to raise capital from the market.

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