Mumbai: Commercial banks could turn to the equity markets to raise capital in 2010 if a Reserve Bank of India (RBI) proposal to exclude hybrid capital from tier I capital is accepted, says a report from Avendus Capital Pvt. Ltd.
Tier I capital comprises both equity and retained profits, while hybrid capital contains elements of both equity and debt.
In its maiden Financial Stability Report, 2010, the central bank said: “Going forward, the focus will increasingly be on substance over form and on tier I rather than tier II capital, especially on common equity. The Basel Committee is developing specific eligibility criteria for inclusion of instruments and elements in tier I capital.”
The Basel Committee on banking supervision is a forum for cooperation between banking regulators.
The exclusion of hybrid capital from tier I capital could lead to 10% equity dilution, said the Avendus report, because it would lead to a lower capital adequacy ratio (CAR), or the ratio of a bank’s capital to its risk-weighted assets that’s a key measure of a bank’s financial strength.
Raising funds: Officials attending to customers at a HDFC Bank branch. Hemant Mishra/Mint
“If the proposed change were to be implemented soon it could pull down capital adequacy of a few banks. This could affect their growth plans if the tier I CAR were to slip below the comfort zone,” said Anand Shanbag, head of research at Avendus Capital.
The Avendus report, however, clarifies that there is unlikely to be any near-term impact as RBI stated during the release of the financial stability report that it “would not revise capital norms immediately, but would adopt a calibrated approach”.
Some of the larger domestic banks that had significant amounts of hybrid capital, close to the threshold limit of 15% of tier I capital, at the end of financial year 2009 were Bank of India (BOI), Union Bank of India, Punjab National Bank, HDFC Bank Ltd and ICICI Bank Ltd, the report said. Hybrid capital as a percentage of net worth is up to 13.3% for some of these banks, it said.
Among the 10 largest banks, hybrid capital as a percentage of tier I capital was the most for HDFC Bank, at 14.5% of the tier I capital and 13.3% of net worth at the end of fiscal 2009. However, due to high price to book, a financial ratio used to compare a firm’s book value to its current market price, HDFC Bank would need to dilute equity by just 3.1% if the RBI proposal is implemented.
An email query sent to HDFC Bank remained unanswered.
However, the central bank in its financial stability report indicated that banks in India are adequately capitalized. The CAR of commercial banks in India improved to 14.1% at the end of December from 13.2% in the end of March 2009.
In April 2006, RBI allowed hybrid instruments, such as perpetual bonds, to be part of banks’ core capital, capped at 15% of tier I capital.
A perpetual bond is one that has no maturity date. The measure was aimed at enabling banks to shore up their capital funds to meet the requirements under the revised framework with the transition to Basel II and to support balance sheet expansion.
Any dilution in equity could also affect a bank’s return on assets. “Return on assets of the banks may also decline, following equity dilution. Therefore, indication towards exclusion of the hybrid capital from the core capital is likely to be sentiment negative,” added the Avendus report.
Other public and private banks said they were not overly worried about the proposal.
A senior official with Union Bank of India, which had CAR of 13.46% as on 31 December and 8.70% in tier I capital, said the bank isn’t worried about the exclusion of hybrid instruments.
“Once the government infuses capital into banks, the details of which will hopefully come within a month, we will have no reason to depend on hybrid capital to boost our tier I capital,” he said, declining to be named because he is not authorized to speak to the media.
BOI may be hit the most due to equity dilution of 10% and therefore the largest decline in the return on asset, or RoA. A senior official at BOI—in which the government has a 64.4% holding, against the minimum of 51%— said that the bank has enough room to manoeuvre even if hybrid instruments are taken away from the capital structure.
The bank’s tier I capital is 9.38% and capital adequacy is 13.64%.
The official, who also did not want to be named, said such a concept would not be in place before 2013, which is what so-called Basel III norms on bank capital have also advised.
“In Basel III, there is a concept called ‘grandfathering’ which means that the existing instruments remain in the balance sheet but no fresh hybrid instrument is added in tier I capital. We have no issue with that,” he said, adding that even if the hybrid was theoretically removed, “Our tier I is pretty comfortable”.
“But I doubt hybrid can be taken away without thinking of any other alternative,” he said.
ICICI Bank, the country’s largest private sector bank, had CAR of 15.5% as on 31 March and hybrid as a percentage of tier I capital of 7.1%. The Avendus report said that in the event of the RBI change happening, ICICI would have to dilute equity by 2.7%.
In an email response, an ICICI Bank spokesperson said that ICICI Bank had hybrid capital of Rs3,000 crore out of tier I capital of Rs42,000 crore, or 0.85% out of the tier I CAR of 11.84% at the end of financial year 2009, and tier I CAR excluding hybrid capital of about 11% against RBI’s requirement of 6%.
At the end of December 2009, tier I CAR excluding hybrid capital was about 13.3%.
“Thus even if hybrid tier I were to be excluded from tier I capital, ICICI Bank’s capital position is very comfortable and there is no question of ICICI Bank needing to raise additional equity for this purpose,” the spokesperson said.
Ashwin Ramarathinam contributed to this story.