MOODY'S: INDIAN PUBLIC SECTOR BANKS FACE HIGH EXTERNAL CAPITAL NEEDS

Moody's Investors Service says that the weak earnings outlook for India's public sector banks highlights their high level of external capital needs and their capitalization profiles will further deteriorate unless the government provides additional capital support.

"Furthermore, the bank's asset quality will remain under pressure over the next 12 months, as they continue to recognize non-performing loans (NPLs) from some of the larger leveraged corporate groups, particularly in the steel and power sectors," says Alka Anbarasu, a Moody's Vice President and Senior Analyst.

"As a result, elevated provisioning expenses will continue to constrain profitability and limit internal capital generation," adds Anbarasu.

Moody's conclusions were contained in a recently-released report on India's public sector banks, "Indian Public Sector Banks: Weak Financial Performance Highlights the Banks' High External Capital Needs".

In view of their results for the fiscal year ended March 2016 (FY2016), Moody's analysis suggests capital requirements of about INR1.2 trillion for its 11 rated public sector banks, far higher than the remaining INR450 billion included in the government's budget for capital distribution to the banks until 2020.

Furthermore, the fact that most bank shares are currently trading below book value constrains their ability to use public offerings to raise capital.

Moody's analysis of the rated public sector banks' capital needs assumes that: (1) they will see an average net new NPL recognition rate of 1.3% between FY2017 and FY2019, including slippages from their restructured loans; (2) credit costs will remain fairly high, at an average of 1.6% over FY2017-FY2019; and (3) they will raise their loan loss coverage by more than 70% by FY2019.

Moody's scenario analysis also assumes a gradual pick-up in credit growth from 10% in FY2017 to 15% in FY2019, driven by both the retail segment and an uptick in corporate loan demand.

However, capital levels have also improved recently on the back of new Reserve Bank of India (RBI) rules that have broadened the banks' capital base. The rules, amended in March 2016, allow the banks to recognize revaluation reserves, deferred tax assets and foreign currency reserves as common equity tier 1 (CET1) capital, in turn resulting in a one-off boost to capital levels.

Specifically, the new rules allow the banks to recognize 45% of their property revaluation reserves, 75% of their foreign exchange translation reserves, and certain deferred tax assets as comprising up to 10% of CET1 capital, in line with the Basel Committee on Banking Supervision guidelines.

The improvement occurs even though the asset quality review mandated by the RBI in the second half of FY2016 -- in an effort to clean up the banks' balance sheets -- has adversely affected profitability.

In particular, the review resulted in higher NPL ratios and increased loan loss provisioning expenses. Eight of the 11 public sector banks that we rate posted a net loss for the full year, and the other three reported a significant decline in their profitability.