Cost of recapitalising state banks may rise, says Fitch

Fitch Ratings on Wednesday stated that the costs the Government of India faces in recapitalising public sector banks (PSBs) could potentially rise if access to the AT1 market weakens.

The view comes after when IDBI Bank's capital injection this month suggested that the government remains unwilling to allow state banks to miss coupon payments on Additional Tier 1 (AT1) instruments. 

"IDBI may have been at risk of skipping a coupon payment without the fresh capital, which might have disrupted the domestic AT1 market and made it more difficult for banks to raise the capital needed to meet Basel III minimum requirements,"said Fitch. 

Investors in AT1 instruments are clear beneficiaries of capital injections and other forms of forbearance, but as per Fitch the senior creditors typically would expect any future losses to be cushioned by AT1 investors first taking losses.

It added, "These policies also create moral hazard by weakening the pressure AT1 instruments should put on banks to recapitalise by raising equity on a more timely and pro-active basis."

Fitch assumes that the government  is likely to continue to ensure state banks do not miss coupon payments considering the market pricing.

"There is some pricing distinction between the larger and smaller state banks, but the small premiums on their AT1 instruments suggest pricing is now largely based on assumptions of state support being provided ahead of banks triggering non-performance clauses," added Fitch.

Fitch continues to believe that private banks will be allowed to skip coupon payments, but most are in relatively healthy positions. 

Between April - till date, AT1 instruments worth around Rs 18,300 crore have been issued by eight banks, compared with Rs 4,800 crore  by four banks in the corresponding period of the previous year.  

However, Fitch said, "Banks are likely to need substantially more than that by FYE19 to meet rising Basel III minimum capital requirements and the government is likely to end up providing much more than the $10.4 billion already earmarked."