Indian banks will have to raise a mountain of capital over the next few years if they have to maintain loan growth as well as meet new international norms. Can they do it? Last week, the Reserve Bank of India (RBI) issued draft guidelines for Indian banks to migrate to the so-called Basel 3 regulatory framework, which defines how much capital buffer banks need to protect themselves against sudden shocks to profitabililty. According to the RBI norms, local banks will need common equity Tier 1 capital equal to 5.5% of their risk-weighted assets (RWAs), up from the current 3.6%. The overall Tier 1 capital should be 7% of RWAs. Banks have to meet this target by 2017; banks in most other countries have time till 2019. According to a study done by rating agency Crisil, Indian banks will need to raise equity capital of Rs.1.4 trillion by March 2017 to raise their capital ratios based on current size of their loan books. This requirement can increase by another Rs.1.3 trillion in case investor appetite is low for non-equity Tier I capital instruments. According to a report on banks and financial institutions by Kotak Institutional Equities, Indian banks have delivered return on equity (RoE) of about 15% over the past few years, and it estimates that every additional 100-120 bps of increase in core equity is likely to impact RoEs by 150-180 bps. Public sector banks are likely to account for the bulk of the requirement to raise the equity and, therefore, are likely to seek a capital infusion from the government, which is already struggling to keep its deficit within safe limits. An infusion of capital by the government goes against the recommendations of the two committees headed by former RBI Governor M.Narsimham, which submitted their reports on banking reforms in 1991 and 1998. The two reports had argued against recapitalization through budgetary provisions, and instead recommended the creation of asset reconstruction funds or companies to take over the bad debts of banks. There are growing fears in the financial markets about the declining asset quality of Indian banks and pressure on the capital adequacy of a few public sector lenders. This and the move to Basel 3 norms could be a tough challenge, especially if the Indian economic slowdown persists.
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