The failure of Dhanlaxmi Bank to pay a coupon on a subordinated debt instrument in July 2016 brings to light the increased risks faced by bank capital investors from the mounting asset-quality and capital adequacy pressures faced by Indian banking sector, said Fitch Ratings.
The global credit rating agency also revised its outlook on the Indian banking sector to negative from stable in July 2016 to reflect the mounting downside risks to standalone credit profiles and high loan-loss provisions.
According to Fitch, the capital position of Indian banks has historically been weak and may continue to be so in near term unless significant fresh capital is infused to counter balance the risks of deteriorating asset quality and weak earnings.
Fitch said Indian banks will need a fresh capital infusion of around $90 billion to meet the Basel III norms by 2019.
On the Dhanlaxmi Bank issue, Fitch said: “This is the first time investors in India have had to forgo interest on a bank capital instrument. We view this as a positive development for a system with a high expectation of support for banks and where moral hazard has developed around the assumption that support could be extended to regulatory capital instruments.”
According to Fitch, the Reserve Bank of India (RBI) can prohibit banks from paying coupons on subordinated debt instruments if capital adequacy ratios fall below the minimum requirements.
It raised these to 9.625 per cent in April 2016 from 9 per cent, exposing creditors to risks at banks with tight capital ratios.
The RBI is progressively pushing minimum capital requirements higher to meet Basel III capital requirements, and will reach 11.5 per cent by end-March 2019. Systemically important banks will have a higher threshold of an additional 0.2 per cent – 0.6 per cent.
According to Fitch, market concerns about bank capital have increased because of the RBI-imposed asset-quality review, which uncovered higher non-performing loans, triggering first-time losses at some banks.
“This limits banks’ ability to generate new capital internally and makes it more difficult for them to access new sources of capital from the market,” Fitch said.
The rating agency said as long as potential capital shortfalls persist, creditors will remain exposed to high non-performance risk, which will affect banks’ market access to new capital. This is likely to put pressure on the government to inject additional capital into the banks, over and above what it has budgeted so far.
Capital ratios are particularly thin at the state-owned banks, which represent around 75 per cent of sector assets in India.
The RBI appears to be making a distinction between banks that have new capital lined up (which so far have been public-sector banks) in decisions about the performance of regulatory capital instruments.
“Where capital ratios fell below, or very near to, regulatory minimum requirements, public-sector banks have received capital injections from the government and were able to make coupon payments on regulatory capital instruments,” Fitch said.
This was the case in 2014 at United Bank of India, and more recently at UCO Bank and Indian Overseas Bank.
“But Dhanlaxmi Bank is a privately owned, small regional bank that was unable to attract new capital from its shareholders. State support appears not to be on offer, and therefore creditors are more exposed to non-performance if there are capital pressures,” Fitch said.
According to Fitch the banking sector’s asset-quality indicators are close to their weakest point, but expect bank earnings to remain weak at least for the next 12-18 months.
“Capital ratios will continue to show signs of strain over the short to medium term, and banks will remain under pressure to raise additional funds. Until they do, risks for creditors will remain high,” Fitch said.