Mumbai: Reserve Bank of India (RBI) governor Raghuram Rajan gave lenders more time to implement Basel III capital requirements, cutting this year’s financing needs by more than 50% amid a surge in bad loans.

RBI on 27 March extended the transition period for meeting the tougher global banking regulations by a year to 31 March 2019, as lenders’ ability to tap capital markets is impacted by deteriorating asset quality. Yields on top-rated 10-year bonds of Indian banks have averaged 9.56% since 31 December versus 9% in 2013. That compares with 2.55% on financial debt globally, Bank of America-Merrill Lynch indexes show.

Rajan is tolerating weaker bank finances just as bad debt is ballooning in Asia’s third-largest economy. Almost 1 trillion of bank loans are at risk of turning sour in India, Fitch Ratings Ltd said in January, and state-owned lenders face the most pressure to raise fresh funds, considering private sector lenders are relatively well capitalized.

“The extra year not only gives banks an opportunity to plan better to conform to Basel III capital norms but also helps investors get accustomed to these new instruments," N.S. Venkatesh, the head of treasury at IDBI Bank Ltd said. “It also aligns India closer to the internationally agreed date for full implementation."

Capital injection

The government on 17 February pledged to inject 11,200 crore of common equity into state-run banks this fiscal year to bolster risk buffers after bad loans climbed to a six-year high. The capital infusion will help lenders boost credit as more borrowers default in an economy forecast by the government to grow 4.9% in the year ended 31 March, compared with the previous decade’s 8.3% annual average rate.

“The RBI’s deferral of Basel III implementation has significantly diminished the need for Tier 1 capital by government banks for the 2014-2015 financial year," said Ananda Bhoumik, a Mumbai-based senior director at India Ratings and Research Pvt. Ltd, Fitch’s local unit. “They now only need 14,400 crore as against 35,600 crore prior to the extension."

The money from the government should also help lenders make up for any shortfall in Tier 1 capital requirements and reduce the need for hybrid-security sales, Bhoumik said.

Higher coupons

The average cost of insuring the bonds of five Indian banks against default for five-years has fallen 146 basis points to 235 basis points on 31 March from a more than one-year high in September, CMA data show.

The Basel Committee on Banking Supervision unveiled rules in December 2010 aimed at boosting the capital of lenders after the 2008 global financial crisis exposed inadequate buffers. Tier 1 capital can absorb balance sheet losses without resulting in the bankruptcy of a company and consists of common stock as well as securities with equity-like characteristics, such as perpetual notes.

The RBI is targeting a minimum ratio of Tier 1 capital to risk-weighted assets of 7% by the end of March 2019, and a total capital ratio of 9%.

Stricter loss-absorption provisions also announced by RBI on 27 March mean investors will now demand higher coupons on banks’ non-equity instruments, making them a more expensive way to raise money, Crisil Ltd, the Indian arm of Standard and Poor’s, said.

Slow sales

Higher premiums will be sought partly to compensate for the risk coupons won’t be paid, considering banks can now only pay interest out of current year profits and not retained earnings, and partly to compensate for the risk principal may be lost, due to a new provision which prohibits banks from opting for a temporary writedown in the event of a breach.

In India, the rules allow the nation’s central bank to seek conversion of non-equity Tier 1 and Tier 2 capital into shares, or write the debt off, should a lender reach a point of non-viability.

There have only been about 280 crore of Tier 1 bond sales under the Basel III regulations in India, compared with 9,350 crore of Tier 2 capital, according to Bloomberg-compiled data. Yes Bank Ltd, a Mumbai-based private sector lender, sold the nation’s first perpetual rupee-denominated Tier 1 Basel III notes in December.

Falling yields

There were no trades in India’s bond and currency markets on Tuesday as banks closed their accounts for the financial year ended 31 March.

Ten-year government bond yields slipped to 8.8% at the end of last quarter from 8.83% on 31 December. The rupee posted its biggest quarterly advance since September 2012, rallying 3.2% to 59.89 per dollar on 28 March, as inflation cooled and the government forecast smaller budget and current-account shortfalls.

Governor Rajan left the RBI’s benchmark repurchase rate unchanged at 8% on Tuesday, having raised it by 75 basis points since taking office in September.

Banks need to raise some 5 trillion to conform to the new capital rules, with as much as 1.75 trillion of that coming from equity sales, RBI estimates released prior to last week’s extension show.

“The Tier 1 capital requirements of state-owned banks, while reducing in the short term, will ultimately increase because of the longer transition period," Icra Ltd, the local unit of Moody’s Investors Service said 31 March.

It estimates the extension period will increase requirements to as much as 4.2 trillion, from 3.3 trillion to 3.6 trillion. Lenders could therefore opt to raise more money than required now because of the higher minimum capital requirement later.

Notwithstanding the short-term breather, banks should actively engage in the capital planning process and oversee its implementation to avoid a last minute rush, Icra analysts led by Vibha Batra wrote. Bloomberg

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