Banks Feel Relaxed After Deferred Basel III

Deferring Basel III will ease banks’ capital needs in the interim, say rating agencies-Business Line

MUMBAI, MARCH 31:  

Though the RBI has given banks a breather by extending the transitional period for full implementation of Basel III regulations by a year, credit rating agencies have warned that investors will seek higher coupons on their non-equity capital instruments.

Last week, the RBI decided to extend the implementation of Basel III capital regulations by a year to March 2019, thereby leading to lower capital requirements for banks in the interim.

According to Crisil Ratings, the extension of the transition period by a year will lead to reduction in capital requirements of banks by ₹40,000 crore up to March 2018 from an earlier estimate of ₹2.7 lakh crore.

However, the capital regulations also increase the risks in the banks’ Tier I capital instruments, and will lead to higher cost for banks.

Pawan Agrawal, Senior Director, Crisil Ratings, said, “This release of capital will enable banks to offset the impact of lower internal generation of capital due to the prevailing squeeze on their profitability in the current economic cycle.”

According to ICRA estimates, Tier I capital requirement of public sector banks to meet growth as well as Basel III norms would increase from ₹3.3-3.6 lakh crore to ₹3.9-4.2 lakh crore due to the longer transition period; while during FY2015-2018, the requirement would fall from ₹3.3-3.6 lakh crore to ₹2.8-3 lakh crore.

“As there is no relief on overall capital requirement on full implementation of Basel III norms, capital would remain a big challenge for PSBs,” the rating agency said.

However, the dependence on raising external capital will remain high, especially for public sector banks.

Key risks

According to Crisil, the guidelines increase the cost of raising Tier I instruments for banks by introducing risk-mitigation features.

The first risk relates to the higher risk of coupon non-payment for investors arising from the stipulations that banks can pay coupon only out of current year’s profits (and not from retained earnings), and that the coupon payout be capped at 40 per cent of a bank’s total distributable surplus for the year.

The second risk is the increase in potential loss of principal due to the provision that disallows banks to opt for temporary write-down in the event of breach of pre-specified trigger.

In ICRA’s opinion investor appetite for permanent write-down feature could be low, this could result in fresh issuances of non-equity Tier I capital instruments only with the conversion feature.

A Fitch Ratings report said, “The flipside is that greater loss absorbency would come at the cost of being less investor-friendly. Tier 1 securities are expected to shoulder a large share of the capital burden and investor appetite is currently limited, adding to the capital raising challenges.”

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Indian banks’ capital challenges eased by Basel III delay: Report

MUMBAI, MARCH 31:  

The RBI’s recent delay of Basel III implementation offers Indian banks more time to meet the minimum capital requirements, Fitch Ratings said in a report.

According to the agency, this could particularly benefit some state-owned banks facing capital pressure.

“The main benefit from the one-year moratorium will be the delay in the phase-in of the capital conservation buffer from end-March 2016 (FY16, which starts April1, 2016), instead of FY15, as most other parameters remain the same. More importantly, banks would get some crucial breathing space from the lower 5.5 per cent pre-specified capital trigger on additional Tier 1 securities until FY19 when it reverts to 6.125 per cent. The headroom of 0.625 per cent will be particularly helpful for mid-sized state-owned banks where capital buffers are particularly challenged,” the report said.

Capital requirements

According to Fitch Ratings, RBI’s actions are a tacit recognition of the potential difficulty state-owned banks would have faced in meeting full capital requirements under the previous timelines.

State-owned banks still need the lion's share of the estimated total core capital requirement for the system, but have thus far largely relied on the Government for new capital because of low internal capital generation and weak access to equity markets.

Basel III instruments

The RBI has also provided additional clarity on Basel III capital instruments and their behaviour, particularly on the issue of loss absorbency. The exclusion of temporary write-downs on Basel III capital instruments reinforces the regulator’s intent to ensure capital securities act like equity when required under stress.

The flipside though is that greater loss absorbency would come at the cost of being less investor friendly. Tier 1 securities are expected to shoulder a large share of the capital burden and investor appetite is currently limited adding to the capital raising challenges, the report added.