The new guidelines issued by the Reserve Bank of India (RBI) which allow allow banks to treat certain assets on their balance sheets as Common Equity Tier 1 (CET1) capital will go a long way in enhancing their equity capital.
Some banks may not find it necessary to raise fresh capital in FY17 unless a significant share is eroded due to higher provisions. The new rules are expected to free up capital estimated anywhere between Rs 25,000 crore and
Rs 35,000 crore.
The revised regulations – allowing a bank to recognise 45% of its revaluation reserves, 75% of its foreign currency translation reserves (FCTR) and deferred tax assets (DTAs) related to timing difference up to a maximum of 10%, as CET1 capital – have brought the rules more in line with those recommended by the Basel Committee on Banking Supervision (BCBS).
A study of bank balance sheets shows the revised regulations will help the top 10 state-owned lenders get around Rs 25,000 crore of additional CET1 capital. This follows the Rs 20,000 crore of revaluation reserves that the State Bank of India (SBI) has indicated it will recognise this financial year (SBI is the only bank among the top 10 PSBs to not have revaluation reserves in its balance sheet). At the top of this list is Canara Bank, which might see its CET1 capital increase by over 11.2% – a big respite, given the fact that it was just 7.37% of its risk weighted assets in FY15. On the other hand, the smallest beneficiary of the RBI move might be Punjab National Bank, given its high CET1 capital ratio of 8.74% and low revaluation reserves of Rs 1,387.6 crore.
While this takes care of concerns over capital raising requirements, and consequent equity dilution concerns in the short run, long-term worries remain. That is because the idea behind higher CET1 capital requirements is to increase the ability of banks to absorb losses – something that won’t necessarily change by the RBI revisions. In a note published on Wednesday, ICRA’s Financial Sector Ratings noted that “reclassification of hidden reserves would help the banks in increasing the Tier I capital by R35,000 crore to R40,000 crore”. It added there is unlikely to be any increase in the loss absorption capacity of the banks. Elaborating this point further, ICRA, said: “…financial institutions and banks shouldn’t hold a lot of fixed assets. So, by making these revisions, RBI might just have encouraged not-so-prudent practices, particularly since it hasn’t put a cap on the revaluation reserve component in CET1 capital.”
It also added that liquidity might be a concern in some of these assets.
Similarly, Siddharth Talwar, Partner, Grant Thornton India, is of the view that the revisions might also lead to PSBs, in some cases, overstating their revaluation reserves to avoid raising capital. “RBI, being more conservative than most central banks, had disallowed Indian banks from recognising revaluation reserves as CET1 capital, although Basel norms do allow such a practice. Now, there will be more power in the hands of individual banks, which might lead to abuse,” he said.