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Bank Recapitalization – Booster Dose To Fuel The Credit Growth

by Tavaga Invest
Bank Recapitalization

In the last 3 months, Canara Bank, HDFC Bank, Bank of Baroda, ICICI Bank, Yes Bank, State Bank of India, Axis Bank, and IDFC First bank, etc. have either made plans to raise fresh capital or have sought approvals from respective boards to infuse capital.

By: Tavaga Research 

Amidst Covid-19, many public and private lenders have adopted measures to raise fresh capital because of high expectations of capital erosion and a rise in Gross NPAs (Non-Performing Assets) due to the ongoing pandemic which has claimed more than 25000 lives in India and an unprecedented economic impact. Taking advantage of greater liquidity in the markets, the banks are about to set a record to make 2020-21 the year for the largest capital infusion ever.

What is Bank Recapitalization?

Bank recapitalization is a method to infuse new and fresh capital into banks to strengthen their balance sheet. To help with the credit flow, the government as well as private institutions use equity and debt instruments to recapitalize the banks. It is very important to ensure the credit growth of the economy.

What Has Gone Wrong with the Indian Financial Space?

Even as the economic activity picked up with the removal of stringent lockdowns in June, India’s financial sector continues to face asset quality risks, risks related to liquidity in NBFCs (Non-Banking Financial Companies), higher credit costs, and some adverse impact of moratoriums.

1.Moratoriums: The uneven situation wherein the borrower of the NBFC is getting a moratorium but the NBFC itself not getting any moratorium on its borrowings will not go well with the weaker and smaller companies as they lack the liquidity because of poor capital adequacy ratios and the overall stress in the sector. With bank lending to NBFCs at an all-time high, there can be a spillover effect as the NBFCs might find it tough or fail to repay the banks. 

The moratoriums have not only caused a headache to NBFCs but also the banks as they expect higher provisions and lesser profits

2.Rise in NPAs: The small and mid-sized private lenders had a tough 4th quarter of FY20 with the City Union Bank, the CSB Bank, and the DCB Bank reporting an increase of gross NPAs (Non-Performing Assets) between 14-20%. IndusInd Bank was an exception in the large-sized banks reporting disappointing NPA figures for the 4th quarter of FY20. 

Along with the private space, the public banks too were exposed to higher NPAs in the 4th quarter of FY20 as the 12 government-controlled banks recorded gross NPAs worth Rs. 5.5 lakh crore which was almost double the size of NPAs recorded by all the 19 private banks. State-controlled Indian Bank reported a 2% rise in NPAs (Total Gross NPAs = Rs. 14,176 crore) and the gross NPAs of Canara Bank rose by 1% to Rs. 37,041 crore. 

While the public sector banks saw a 5% decline in gross NPAs (Year on Year basis), the number is expected to grow further in the Q1 and Q2 of FY21 because of the adverse impact caused by the pandemic due to Covid-19.

Even globally, the banks have made provisions as there are expectations of loan defaults and rising NPAs. JP Morgan, in its latest quarterly update in July, set aside a sum of $8.9 billion as it expects default in the consumer and commercial banking business. The Citigroup set aside $7.9 billion fearing defaults. Wells Fargo had to report a loss of $2.4 billion after adding $8.4 billion in its reserves against loan losses

3.Worsening asset quality: With disruptions in day to day business activity coupled with issues relating to global supply chains due to the Covid-19 pandemic, the stressed financial entities are exposed to greater risk than before. 

Along with weak credit growth and rising NPAs, business shutdowns might be yet another cause for high stress to the financial sector. Also, the extension of the moratorium scheme up to August 2020, will further lead to tremendous pressure on the asset quality of smaller and weaker financial companies

Banks on a Recapitalization Spree

To display a resilient balance sheet and strengthen the business, many lenders have resorted to fresh capital in these tough circumstances. Here are some of the latest instances where the banks have either made plans to raise money or have received approvals from the board to infuse capital:

  • State Bank of India: The central board of SBI approved to raise Rs 25,000 crore to strengthen its balance sheet and further improve the capital adequacy ratio
  • HDFC Bank: In June 2020, the board of HDFC Bank approved its proposal to garner Rs 50,000 crore via issuance of debt securities
  • Kotak Mahindra Bank: The Kotak Mahindra bank raised Rs 7,442 crore as early as May 2020 by selling new equity shares through a Qualified Institutional Placement (QIP) to finance new business opportunities arising out of COVID-19 and to boost its balance sheet with expectations of higher slippages
  • Canara Bank: Canara Bank has targeted to raise Rs 5000 crore in FY21 to expand its operations, implement the Basel III norms, and to boost the capital adequacy ratio

Below is the list of banks who have either raised funds or they are planning to raise:

List of banks that have raised funds
Source: Tavaga Research

According to rating agency ICRA, the initial requirement of fresh capital for government-owned banks was Rs 10,000-20,000 crore for FY21, however, the Covid-19 crisis has caused the capital requirements to rise to Rs 45,000-82,500 crore for public sector banks and Rs 25,000-48,300 crore for private sector banks. 

The rating agency further stressed on the moratoriums concerning the NBFCs. As of May 2020, a little more than half of the entire AUM of the NBFCs were under moratorium. A default of 10% of the loans under moratorium would’ve led to doubling of gross NPAs of NBFCs (from 4.6% of the entire loan book as of March 2020 to 9.6% of March 2021). 

Macquarie in its report on 3rd June estimated the loans under moratorium to go beyond 50% of the total loans (concerning the banks) by end of August and further increasing the risk of default to the banking sector. Some portion of the loans under moratorium is expected to get converted to Non-Performing Loans (NPLs) thus increasing the figures of gross NPAs. 

It should also be noted that the RBI has, for the time being, given relaxation to banks concerning NPA recognition of MUDRA (Micro Units Development and Refinance Agency Ltd), MSME, and commercial real estate loans. 

The Use of Recapitalization Bonds by Government in the Past:

In 2017, the government announced its bank recapitalization plan for the public sector banks through the recapitalization bonds. The banks were to subscribe to the government-issued recapitalization bonds by lending money to the government and thus showing it as an investment in their books.

The money borrowed by the government would be again flushed into the banks as capital, and as a result, the weaker balance sheets would be to strengthen with higher capital adequacy ratios.

This process was done to eliminate any direct impact on the fiscal deficit at that point in time.

Impact on Punjab National Bank’s stock price post finance minister’s bank recapitalization announcement

PNB share movement
Source: moneycontrol.com | The share surged almost 40% reacting positively to the bank recapitalization plan

Impact on State Bank of India’s stock price post finance minister’s bank recapitalization announcement

SBI share movement
Source: moneycontrol.com | The share surged almost 27% reacting positively to the bank recapitalization plan

Impact on Canara Bank’s stock price post finance minister’s bank recapitalization announcement

Canara Bank Share movement
Source: moneycontrol.com | The share surged almost 34% reacting positively to the bank recapitalization plan

Apart from 2017, there have been 2 instances in the past where the government had infused capital by way of recapitalization bonds.

  • For compensating the under-recoveries in domestic LPG business, 3 special bonds were issued to state-controlled Oil Marketing Companies (OMCs) worth Rs. 5,750 crore in 2006
  • In the 1990s, banks were infused with capital via bonds as the banks at that time faced liquidity crunch due to irrational lending to the private sector 

Intending to build a robust financial network and withstand the fears caused by the pandemic, it has become necessary for banks to raise capital not only to maintain the capital adequacy ratio but to go beyond the minimum requirements this time. 

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