Fitch Ratings indicated on Wednesday that the recent capital injection into IDBI Bank suggests the Indian government remains unwilling to allow state banks to miss coupon payments on additional Tier-1 (AT1) instruments. Fitch pointed out that the bank may have been at risk of skipping a coupon payment without the fresh capital, which might have disrupted the domestic AT-1 market and made it more difficult for banks to raise the capital needed to meet Basel III minimum requirements. These policies also create a moral hazard by weakening the pressure AT-1 instruments should put on banks to recapitalise by raising equity on a more timely and pro-active basis, it said in a release.
The ratings agency also indicated that yield spreads between Indian AT-1 instruments and gone-concern Tier-2 debt have gradually tightened over the previous few years.
“The narrowing has been largely driven by market expectations of forbearance as well as strong AT-1 demand from mutual funds, which received a surge in liquidity after demonetisation brought cash back into the formal financial sector,” Fitch observed.
Market pricing appears to assume that the government is likely to continue to ensure state banks do not miss coupon payments.
“There is some pricing distinction between the larger and smaller state banks, but the small premiums on their AT-1 instruments suggest pricing is now largely based on assumptions of state support being provided ahead of banks triggering non-performance clauses,” Fitch said.
Fitch continues to believe that private banks will be allowed to skip coupon payments, but most are in relatively healthy positions. AT1 instruments worth around Rs 18,300 crore have been issued by eight banks in April-August, compared with Rs 4,800 crore by four banks over the same period in 2016.