Almost at the end of every fiscal, public sector banks approach their majority shareholder (the government) with a request for more capital. A number of these banks do not use their capital efficiently and now with higher provisioning for non-performing assets (NPA) as well as the new Basel III norms, these banks will need a larger chunk of capital from the government. According to the Reserve Bank of India (RBI) Governor D Subbarao, the government would need to infuse Rs 900 bn in public sector banks in order to maintain its current shareholding after the new Basel-III norms come into force. If it is willing to reduce its stake in these banks to 51%, the burden may come down to Rs 700 bn.
According to the central bank governor, the government may issue recapitalization bonds as against an infusion of common equity. Indian banks have so far raised equity capital of around Rs 520 bn through the primary markets over the last five years. Therefore, raising an additional Rs 700 bn to Rs 1 trillion over the next five years from should not be too much of an issue. There is an extended period spread over five years (Jan 2013-March 2018) for Basel III implementation. This gives sufficient time to banks to plan their capital-raising efforts over the period. The banking regulator had put out the final guidelines on Basel-III norms and its implementation in May 2012, as seen below.
* The difference between the minimum total capital requirement of 9% and the Tier 1 requirement can be met with Tier 2 and higher forms of capital
Data Source: RBI
According to RBI estimates, Indian banks would require additional capital of Rs 5 trillion to meet Basel-III norms by March 31, 2018. That includes non-equity capital of Rs 3.3 trillion and equity capital of Rs 1.8 trillion. Now with an additional capital infusion, the return on equity of the Indian banking system is expected to decline over the short term on the adoption of Basel-III norms. The average return on equity for the banking system has been about 15% for the last three years (as per RBI data). We concur with the central bank governor that the effective implementation of Basel III norms would make Indian banks stronger and more stable. This will help them have a sound capital cushion which will help them deliver value to the various sectors of the economy that desperately need financing. However, if the capital is to be raised through equity issuances, investors would need assurance of sustainable return ratios and better asset quality.