Indian banks need Rs5,00,000 crore fresh capital under Basel III: RBI governor

Banks in India will require additional capital of Rs500,000 crore by the year 2018 in order to comply with the Basel III regulations, RBI governor Duvvuri Subbarao said today.

RBI estimates project an additional capital requirement of Rs5,00,000 crore, of which non-equity capital will be of the order of Rs3,25,000 crore while equity capital will be of the order of Rs1,75,000 crore, Subbarao said while speaking at the FICCI-IBA banking conference.

He said if the government, which holds a 70-per cent stake in the banking industry, opts to infuse the necessary funds, it would have to provide for Rs90,000 crore for recapitalising state-run banks so as to maintain majority share holding under the Basel III.

Indian banks already meet the minimum capital requirements of Basel III at an aggregate level, even though some individual banks may have to top up he said, adding this may not remain so going forward.

Currently, the bank credit to GDP ratio in India is around 55 per cent. This ratio will have to go up as the economy goes through a structural transformation, as it should. The share of the industry sector will then increase and the credit-GDP ratio will rise even further. This, he said, would be required even in the absence of Basel III.

The size of the additional capital required to be raised by Indian banks depends on the assumption made, and there are various estimates floating around.  The RBI has made some quick estimates based on the following two conservative assumptions covering the period to 31 March 2018:

• Risk weighted assets of individual banks will increase by 20 per cent per annum; and 
  
• Internal accruals will be of the order of 1 per cent of risk weighted assets.

According to Subbarao, the amount the market will have to provide will depend on how much of the recapitalisation burden of PSBs the government will meet. This amount is estimated to be in the range of Rs70,000 crore to Rs1,00,000 crore depending on how much the government will provide.

Over the last five years, banks have revised equity capital to around Rs52,000 crore through the primary markets. Raising an additional Rs70,000 crore to Rs1,00,000 crore over the next five years from the market should therefore not be an insurmountable problem. The extended period of full Basel III implementation spread over five years gives sufficient time to banks to plan the time-table of their capital rising over this period, he said.

The government owns 70 per cent of the banking system and if the government opts to maintain its shareholding at the current level, the burden of recapitalisation will be around Rs90,000 crore; on the other hand, if it decides to reduce its shareholding in every bank to a minimum of 51 per cent, the burden reduces to under Rs70,000 crore, he noted.

A tempting option for the government would be to issue recapitalisation bonds against common equity infusion. But this, he said, will militate against fiscal transparency. In the alternative, the government could think of reducing its shareholding in PSBs to below 51 per cent. If the government decides to pursue this option, an additional consideration is whether it will amend the statute to protect its majority voting rights.

On the criticism against Basel III that it will hurt growth, the governor said there is no precise quantitative estimate of the impact on growth and the issue will be discussed at a time when credit demand in the economy will be on the rise.

In a structurally transforming economy with rapid upward mobility, credit demand will expand faster than GDP for several reasons.

What all this means is that we are going to have to impose higher capital requirements on banks as per Basel III at a time when credit demand is going to expand rapidly.

Admittedly, the cost of equity capital is high. It is also likely that the loss absorbency requirements on the non-equity regulatory capital will increase its cost.

The average return on equity (RoE) of the Indian banking system for the last three years has been approximately 15 per cent. Implementation of Basel III is expected to result in a decline in Indian banks' RoE in the short-term.

 However, the expected benefits arising out of a more stable and stronger banking system will largely offset the negative impact of a lower RoE in the medium to long term. It is also fair to assume that investors will perceive the benefits of having less risky and more stable banks, and will therefore be willing to trade in higher returns for lower risks.

Indian banks' ability to bear the increased cost of capital will depend on the tradeoff between credit cost and net interest margins.

It is also doubted that the mandate to maintain a higher quantum of liquid assets will encourage banks to resort to the passive option of lending to the government, thereby crowding out credit to the private sector. But this will resolve itself as the savings rate of the economy improves and the fiscal deficit comes down.

He said there are two views on the extent banks' holding of government securities that should be taken into account for assessing compliance with liquidity standards. The Reserve Bank will take a view on this in due course.

Finally, the effects of Basel III on the profitability of banks will depend on their incentive structure and the competitive dimensions of our banking sector, which would ensure that banks are able to deliver efficient financial intermediation without compromising the interests of depositors and borrowers.

However, he said, some of the prescriptions of Basel III have already been in existence in India, and the net additional burden will be lower than we tend to imagine.