India’s state-owned banks will be forced to merge with smaller public lenders as rising bad debt and weak growth trigger a higher need for capital and make it difficult to fulfill Basel III requirements.
Over the next five years, India’s entire banking sector will require up to US$60 billion in capital to meet new Basel requirements, and at least half of that amount will be needed by the public banks, CLSA’s Aashish Agarwal said in an interview with Asiamoney PLUS. This may prompt the government to direct larger banks to take over smaller peers to free up more capital to boost requirement ratios.
“For state-owned banks, half of it [equity capital] has to come from the government. It’s kind of difficult for the government to put in at least US$20 billion of equity in these banks especially as some of these banks will see an erosion of profitability,” said Agarwal. “The government may look to merge a few banks and look at the large banks. Twenty-seven banks raising US$40 billion will be more challenging than a handful of banks raising US$4 billion each.”
Bank consolidation could happen within state-owned banks that are in the same region, said Agarwal, citing South Indian banks like Canara Bank as possibly taking over smaller banks like Vijaya or Syndicate Bank. Meanwhile, banks located in the north such as Oriental Bank of Commerce may be asked to be taken over by Punjab National Bank.
Similarly, smaller western banks like Dena Bank could be asked to be taken over by dominant players within their region. The merging would occur after the first round of Basel III requirements, said CLSA’s Agarwal.
“It will happen post March 2014-15 when the capital needs really start hurting. As of now the banks should be able to raise money because in some cases the government ownership is 60%, 58%, 59% and the government will look to bring it down to 51% or so. It’s only post 2014 when the second round of Basel III requirements hit that’s when the real pressure for consolidation starts,” he said.
So far, Indian banks’ capital levels are well over Basel III rules, which require banks to hold 4.5% in minimum Tier I capital by January 2013, 5.5% at January 2014, and 6.0% by 2015. Currently the public-sector banks’ average a ratio of 9.1%, but this will see a significant drop as a deterioration in asset quality, continued weak growth and an end to central bank exemptions on pension hurt their capital ratios.
“The challenge lies in meeting the Basel III capital norms if the asset quality deterioration continues, said Vineet Gupta, the primary banking analyst for India at Moody’s. “That’s what we’ve seen over the last 18 months for public sector banks. Most of these banks reported more than double the gross NPL numbers. If I add on top of that the restructured loans, the numbers look really bad. Moody’s-rated banks currently have an average Tier 1 ratio of about 10%, but maintaining this level will be a big challenge for them given their low internal capital generation.”
Data that measures the deterioration of asset quality among 11 public-sector banks rose to 3.2% in June compared with 2.1% in March 2011, according to Moody’s estimates. That compares with an improvement among four private-sector banks of 1.4% in September compared to 1.7% in March 2011.
The push to merge these banks is expected to be stimulated by the government, according to another financial institutions strategist in Hong Kong, and may induce them to visit the international bond markets to fund these activities.
Indian issuers have raised a record US$5.1 billion in dollar-denominated bonds from global creditors so far this year, according to Dealogic, amid record-low interest rates and the need by state-owned and privately-owned banks to refinance their loans. Government support helped Syndicate Bank price its US$500 million deal at a record tight spread of 355 basis points (bp) over Treasuries on October 9, after the likes of State Bank of India, Export-Import Bank of India, Axis Bank, and United Overseas Bank also tapped the market this year.
The ability of government-owned banks to price at competitive spreads may tighten further if the systemic importance of the lender rises with smaller bank acquisitions. Bank bonds that were issued so far this year included covenants that protect international creditors from negative events due to a decrease in government ownership.
“It will have to be a really meaningful change,” said the strategist. “Like if an Indian bank goes out and acquires five to six banks and all of a sudden becomes the third-largest bank, that will change the credit profile. One acquisition is not going to change it too much.”
An unwinding of public ownership in State Bank of India will not affect the bond spreads in its future international bond issues, the strategist added, as the bank is a top lender that India cannot afford to let it fall. But the story is drastically different for smaller banks if they were to issue bonds after they become privatised.
“In the event that the government does sell down its stake and then these bonds are not protected by it, there becomes a lot more importance on the fundamental credit profiles which are quite weak,” said the strategist, who said spreads will widen by at least 30bp.