The calls for the Reserve Bank of India (RBI) to cut rates only get more strident. The central bank’s own adviser Arvind Virmani said last week there was room of 1.25 percentage points more for a policy rate cut. But forget the high level of lending rates of the moment, do banks have enough capital to lend in case the elusive economic recovery materializes later this year?

The answer seems to be no, especially since minimum total capital requirements are set to rise this financial year. According to RBI’s timeline for implementing Basel III norms, banks have to provide for a capital conservation buffer of 0.625% of risk-weighted assets by the end of this financial year. Including this, the minimum total capital requirement will increase to 9.625%. In the next financial year, this increases to 10.25%.

While the big state-owned banks such as State Bank of India, Bank of Baroda and Punjab National Bank have relatively comfortable capital positions, the situation is dire for mid-cap public sector banks, which account for around one-third of bank credit.

According to India Ratings and Research calculations, these mid-level banks require 1.6 trillion in capital over the next four financial years to meet the Basel III requirements. But for the moment, there seems to be little chance of getting this capital. With credit costs high and loan growth already low, the contribution from retained profits is abysmal.

Government help is inadequate. Only 7,940 crore has been earmarked for bank recapitalization this fiscal. Last year, only 7,000 crore was infused, lower than the budget target of 11,200 crore. The policy for bank recapitalization is whimsical. Last year, it was based on performance and this year, it will be based on individual needs of lenders.

With most public sector banks trading at below their book values, raising money from the capital markets is a tough proposition. In any case, the government is reluctant to cut its stakes.

The upshot is that credit growth will be hurt. According to India Ratings projections, in the absence of government capital infusion, average annual bank credit growth over the next four financial years could plummet to as low as 6.35%. Even if the government manages to pump in half the required capital, credit growth would be tepid at 10.8%.

Private sector banks, which are better capitalized, will be unable to take up the slack. They would also be unwilling to bear the burden. Public sector banks lend across the spectrum from farmers to textile companies to small and medium enterprises as compared to private sector lenders who focus more on consumer and corporate lending. The small and marginal sectors are the ones that face the spectre of credit starvation if bank capital isn’t forthcoming.

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