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Business News/ Market / Mark-to-market/  Band-Aid for banks
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Band-Aid for banks

The Nifty PSU Bank index rallied 9.9% on Wednesday after RBI announced new norms to alleviate the near-term capital concerns of public sector banks

The new capital norms will release an additional `35,000 crore into the banking system.Premium
The new capital norms will release an additional `35,000 crore into the banking system.

The Nifty PSU Bank index rallied 9.9% on Wednesday after the Reserve Bank of India (RBI) announced new norms to alleviate the near-term capital concerns of public sector banks.

RBI has allowed banks to consider revaluation reserves linked to their property holdings (at a discount of 55%) and foreign-currency translations as Tier-I or core capital. The central bank has also allowed deferred tax assets to be included, up to a maximum of 10% of the common equity Tier-I capital.

The new capital norms will release an additional 35,000 crore into the banking system. This will boost Tier-I ratios of public sector banks by around 20-100 basis points as you can see in the chart. This is a big relief, following the disappointment over the budget allocation of 25,000 crore for public sector banks under the Indradhanush plan.

Note that most of the state-run banks’ stocks were already trading at very cheap valuations as investors dumped these shares in the past few months over asset quality concerns and low capital adequacy ratios. The Nifty PSU Bank index has fallen 30% since the beginning of January until before the budget. For now, the gains in banking stocks are more of a relief rally as the new capital norms reduce the dilution risks in the near term. Credit Suisse estimates dilution risks for banks to come down by 10-40% on account of the Tier-I increase.

Also, capital ratios for most public sector banks would have fallen below RBI’s minimum requirement of 5.5% in the current quarter due to the surge in non-performing assets, since at least half of the doubtful loans are yet to be declared as bad under the central bank’s asset quality review in the March quarter. The capital increase, therefore, is a big relief, putting to rest near-term risks.

But public sector banks are far from being out of the woods.

First, they would need a further $24 billion, or 1.6 trillion, of capital to increase the coverage on recognized stress, according to Credit Suisse estimates.

Stressed assets—bad loans and restructured advances—are at over 13% for public sector banks. Given low earnings, longer-term issues on improving the economic capital as well as asset quality need to be addressed, said Vibha Batra, group head (financial sector ratings) at Icra Ltd.

Second, loss absorption capacity for this type of Tier-I capital is likely to be lower because real estate liquidation of large ticket size is easier said than done, according to a Kotak Institutional Equities’ note.

In short, investors should continue to view public sector bank stocks with utmost caution. Unless banks are able to increase their credit growth and reduce the quantum of bad assets, the tide is yet to turn in favour of public sector lenders.

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Published: 03 Mar 2016, 12:27 AM IST
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