The rocky road ahead for capital-starved PSU banks

Moody’s Investors Service downgraded Central Bank of India and Indian Overseas Bank’s local and foreign currency deposit ratings last week, reflecting lower support from the government after it allocated capital of only ₹ 7,940 crore for the coming fiscal in the budget. The going is likely to get tougher for smaller public sector banks in terms of growing their balance sheet and they will have to fend for themselves.

add_main_imageIs their stock performance reflecting these concerns?

After going up in the past one year, the share prices of smaller state-run banks have fallen only marginally after the budget, although the government’s intent is clear that capital infusion could be a function of their ability to generate profits. NextMAds

Given the government’s meagre capital for the coming fiscal, compared with an estimated requirement of ₹ 2.5 trillion over four years, analysts expect only around 10 of 26 banks may get capital from the government.

With over two-fifths of public sector banks with a core capital ratio less than 8% and around two-thirds with core capital of less than 9%, lack of capital is going to constrain their ability to grow, said Credit Suisse Securities Pvt. Ltd in a research note dated 28 February. Public sector banks are hamstrung by not being able to cut costs by reducing head count or wages and they will have no option but to start selling their non-core assets or shrink their balance sheet size.

Some lenders have already started selling assets. Central Bank of India is looking to sell its stake in its housing finance business. IDBI Bank Ltd took approval from the government to offload its stake in National Stock Exchange of India Ltd and Credit Analysis and Research Ltd in December to meet its capital requirement.

Even if these state-owned banks become aggressive in recovering bad loans, lower loan growth will keep balance sheets under pressure.

Moreover, if their debt gets downgraded, they will find it difficult to raise money. sixthMAds

“There are only two options: the smaller banks will be forced to stop growing; and if they cannot grow, they will merge with larger banks,” said Adarsh Parasrampuria, vice-president, banks and financials, equity research, Nomura Financial Advisory and Securities (India) Pvt. Ltd.

Of course, these banks are government entities and depositors’ interest will be protected. But over a period, if these banks don’t get money, it opens a window for some consolidation, as large public banks grab market share from these smaller banks.

Diwakar Gupta, former chief financial officer of State Bank of India, said, “We are talking about the extinction of the capital-starved smaller public banks as they could be sold for less or half their book value in the coming years.”

The price to book value of some of these small state-run banks is already low (see chart). Given this bleak outlook, their share prices could fall further.

The writer does not hold positions in the companies discussed here.