India Allows Increased Private Ownership in State Banks, a Credit Positive

Gene Fang, Vice President - Senior Credit Officer, Financial Institutions Group, Moody's Investors Service Singapore

On 10 December, India's cabinet said that it would allow government ownership in public-sector banks to fall to 52% as the banks raise capital to meet Basel III requirements, which will steadily rise until 2019. The ability to raise private capital that dilutes the government's stake is credit positive for undercapitalized public-sector banks because government resources to recapitalize the banks are limited.

Of the 11 public-sector banks we rate, the Indian government's stakes range from 56% to 84%. Public sector banks account for about 70% of the Indian banking system in terms of loans, deposits and branches. The cabinet stopped short of allowing public-sector banks to reduce their government stakes below 51%, a level that would jeopardize government control of the banks.

 

The cabinet said a phased reduction in the government's stakes in the banks to 52% would raise up to INR1.61 trillion in funds from the market, leaving the government to provide INR789 billion from the federal budget to support the banks' capital between 2015 and 2019 (or INR444 billion in net outlays, after accounting for dividends the government expects to receive from the banks). This compares with the INR1.5-INR2.2 trillion of Tier 1 capital that we recently estimated the 11 rated public-sector banks would need to raise externally either from the government or the markets to meet Basel III's full implementation in the fiscal year ending 31 March 2019.

Over the past four years, the Indian government has provided INR586 billion of capital to public-sector banks to support growth in risk-weighted assets that has exceeded their internal capital generation.

Slower economic growth in India and the need to provision for large amounts of problem loans has hurt public-sector banks' profitability and their ability to generate capital internally. The government has allocated a further INR112 billion in the budget for the current fiscal year, but Prime Minister Narendra Modi had been reluctant to provide support beyond that amount.

If the 11 rated public-sector banks were to immediately issue new shares to dilute the government stake in each bank to 52%, it would generate INR729 billion in new capital at current market prices, which we estimate would lift reported Tier 1 ratios to 8.2%-12.2% from 7.3%-9.6%.

The ability of Indian public-sector banks to raise equity from the markets improved this year amid an increase in bank share prices, as reflected by a 90% jump in India's National Stock Exchange CNX Bank Nifty Index over the past year. Nonetheless, many of the banks still trade at a substantial discount to book value, compared with Indian private-sector banks, which traded at price-to-book multiples of 2.5x-4.6x as of 15 December.

We expect those public-sector banks trading at higher price-to-book ratios, including State Bank of India (Baa3 stable, D+/ba1 negative), at 1.5x, and Bank of Baroda (Baa3 stable, D/ba2 negative), at 1.2x, to have an easier time raising equity capital. But the cabinet is also providing weaker public-sector banks with lower price-to-book ratios greater latitude to raise capital, since majority shareholder dilution will be less of a constraint.

Even if the government's stake in these banks declines, we do not expect a decrease in systemic support for senior creditors, given that the government will retain controlling interests in the banks. Also, a default of senior obligations at any single public-sector bank would have high risk of contagion given that public-sector banks hold more than 70% of India's banking system assets.

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