Indian Government bank capitalisation decision positive for market confidence

The Government of India’s (GoI’s) recent decision enabling public sector banks (PSBs) to enhance their capitalisation will give a welcome boost to market confidence in these banks. The decision, which comes at a time of unprecedented turmoil in the banking sector across the globe, will help PSBs increase their capital adequacy ratios (CARs) to 12 per cent.

Even at present, Indian banks are adequately capitalised. According to Raman Uberoi, Senior Director, CRISIL Ratings, “This move by GoI will further strengthen the capital adequacy of the Indian banking system. In particular, PSBs with CARs lower than 12 per cent will be able to improve their capitalisation levels.”

CRISIL also sees the move as part of GoI’s efforts to help banks keep up the tempo of credit growth, supporting economic development. Given GoI’s majority ownership in PSBs, and the criticality of the banking sector to the economy, CRISIL’s ratings on PSBs centrally factor in GoI support.

While the details of the GoI decision are awaited, CRISIL believes that PSBs with GoI holdings very close to the minimum level of 51 per cent will benefit the most, as they have limited or no flexibility to raise equity capital unless GoI subscribes to their rights issues.

In particular, the capital infusion could have a positive effect on the ratings of hybrid instruments issued by these PSBs, since CRISIL’s hybrid ratings factor in the possibility of breach of regulatory CAR, and an enhancement of the banks’ CARs will make the likelihood of such a breach more remote.

According to Tarun Bhatia, Head, Financial Sector Ratings, “The additional capital infusion will provide adequate cushion over the regulatory CAR for the time being. However, for higher hybrid ratings to hold, banks have to maintain their CARs well above the regulatory minimum, which they may find difficult to do given the current operating environment.

CRISIL believes that banks will need to tap more sustainable sources of capital in order to support credit growth.” CRISIL will take appropriate rating actions once all the details regarding the planned capital support have emerged.

(This is press release of CRISIL dated October 22, 2008)

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