RegTech Intelligence

Increases in capital requirements under Basel III is posing a challenge for Indian banks

Fitch Ratings, one of the largest three credit rating agencies, released a report on 11 September 2016 on how the Reserve Bank of India’s (RBI) increase in capital requirements under Basel III is likely to put nearly half of Indian banks in danger of breaching capital triggers. They emphasised that government owned banks are the most at risk due to their poor existing capital buffers and weak prospects for raising capital through market channels, which will keep their Viability Ratings under pressure which measures the intrinsic credit-worthiness of a financial institution (FI). This could hugely impact the outlook of the financial sector in India.

Their analysis shows the total capital adequacy ratio (CAR) for 11 of the 27 Indian state owned banks was either at or lower than the minimum of 11.5% required by the financial year end 2019 (FYE19). As mentioned earlier, public sector banks are most at risk for not meeting capital requirements. Therefore, this percentage of banks either at or lower than the minimum requirement of 11.5%, may not come as a huge surprise because earlier this year, Dhanlaxmi Bank, a private-sector bank, had a CAR of 7.51% which was below the FYE16 regulatory requirement of 9.625%.

Out of the 11 banks, six did not have enough capital to meet the minimum requirement by FYE17 which is a CAR of 10.25%. These figures show that banks will need to swiftly raise capital in order to meet the requirements and this is posing to be quite a challenge. Despite increasing the CAR ratio steadily year by year, this demonstrates that banks are under a lot of pressure to meet the regulatory requirements. Fitch has previously estimated that Indian banks “will require around USD90bn in new capital by FYE19 to meet Basel III standards, with the state banks accounting for about 80% of the total.”

According to Fitch, “the government has already earmarked INR700bn (USD10.4bn) for capital injections into state banks” over the four-year period until FYE19. The government has already put in INR250bn in the FYE16. In July, they announced that “INR229bn (USD3.4bn) was being frontloaded.” This means priority will be given to banks that require new capital the most and will need to continue to rely on the government for capital infusion to address their ongoing capital needs. The heavy reliance on the government for new capital shows the difficulty of public sector banks’ ability to generate internal capital due to pressures on their asset quality and sharp deteriorating financial profiles that have occurred over the past few years; for example, the State Bank of India, India’s largest bank, currently has a credit rating of BBB-/stable. Fitch believes that more capital from the government will “restore market confidence,” and this will perhaps in turn help banks raise capital on their own.

Indian banks are also facing another regulatory challenge which is meeting the IFRS 9 financial instruments accounting standards, which is being implemented by the International Accounting Standards Board (IASB). It was drafted as a response to the financial crisis and the final version was issued on 24 July 2014. It is set to become effective on or after 1 January 2018, replacing IAS 39 and superseding all previous versions. The accounting standard “includes a logical model for classification and measurement, a single, forward-looking ‘expected loss’ impairment model and a substantially-reformed approach to hedge accounting.” However, it should be noted that the IFRS 9 “does not replace the requirements for portfolio fair value hedge accounting for interest rate risk.”

Indian banks are not the only ones who are having challenges in regards to meeting the capital requirements, as UAE banks are also expecting to face several challenges. This adds to the current on-going pressure and criticism the Basel Committee are facing as banks have argued that the proposed changes in capital requirements are too high, dubbing it as Basel IV. The Group of Central Bank Governors and Heads of Supervision (GHOS) met on 11 September 2016 to discuss the progress and review the impact of the Basel III reforms. They concluded that the Basel Committee are on the right track to complete their year-end objectives and have approved the general direction of the reforms. However, they too have cautioned the Basel Committee not to significantly increase banks’ capital requirements.

Given the concerns raised over the increase in requirements as well as the consequences associated with it, one of them being an increase in costs, banks are expecting some of the final rules to be less rigorous.

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