Indian state-run banks are staring at protracted weakness in their credit growth due to limited capital support from the government as well as risk aversion approach, says international ratings agency Fitch Ratings. The public sector banks' prospects for new business and revenue generation are likely to remain muted in 2021 due to moderately worse operating environment for the Indian banking sector, it said.
As per the agency, PSU lenders have so far managed to avert further pressure on their weak core capitalisation due to regulatory forbearance, limited risk underwriting and lower credit growth.
PSU banks are yet to receive the proposed capital injection of $2.7 billion in FY21, although the agency believes that more is needed to face the asset-quality challenges in the foreseeable future. Fitch's estimate pegs the banking sector's capital requirement between $15-58 billion under various stress scenarios for the next two years, of which state banks account for the bulk.
Fitch said that the banking sector could rebound strongly if PSU banks, which account for 60 per cent of sector assets, were substantially recapitalised. It could potentially mitigate capital risk on account of a weak asset quality outlook and limited loss absorption buffers while leaving enough for the banks to benefit from subdued - but very slowly recovering - corporate and consumer confidence; broadly in line with private banks, it said.
As per the Fitch report, state-owned banks' access to capital markets is currently limited. They collectively raised equity of about $1 billion between August to December 2020 from the capital markets, as banks had to settle for considerably smaller amounts even when compared with their modest expectations. In contrast, large- to mid-sized private banks raised close to $6.8 billion in 2020-2021, adding roughly 125bp-250bp in terms of risk-weighted assets versus 20bp-60bp by PSU banks.
The report noted that Additional Tier 1 (AT1) instruments have emerged as the capital instrument of choice for state banks as they strive to shore up capital ratios. State banks have cumulatively raised around $2.3 billion in AT1 instruments in 2020-2021, amid a virtual absence of such issuance by private banks (barring one instance) in the aftermath of YES Bank's AT1 write-down in March 2020. AT1 instruments still account for a relatively small proportion of the capital structure (averaging roughly around 1 per cent of risk-weighted assets) but are increasingly finding favour among state banks, ostensibly as an alternative to equity.
Fitch, however, does not see AT1 instruments as a substitute for core equity, yet it expects more such issuance by the state banks, based on the broader market assumption that an event involving either non-payment of coupons or loss on these instruments is unlikely. However, the risk persists as available CET1 (Common Equity Tier 1) buffers at state banks are thin while they remain heavily dependent on the state for equity support, it said.