Consolidation Not The Answer To Banking Sector Stress: Rating Agencies

Moody’s estimates that the 11 public sector banks rated by it will require up to Rs 95,000 crore by 2019.

A pedestrian walks past a branch of Indian bank in Mumbai. (Photographer: Abhijit Bhatlekar/Bloomberg News)
A pedestrian walks past a branch of Indian bank in Mumbai. (Photographer: Abhijit Bhatlekar/Bloomberg News)

Consolidation of state-owned banks cannot be seen as an immediate solution to the stress being faced by the banking sector, according to rating agency Moody's Investors Services Ltd and its local affiliate ICRA Ltd. Mergers will do little to resolve the issue of a high level of stressed assets on the books of banks and will not result in any meaningful release of capital, said representatives of the rating agencies on the sidelines of a Moody’s Investor Conference in Mumbai on Thursday. Moody’s estimates that 11 public sector banks, which it rates, would need up to Rs 95,000 crore over the next two years.

"Merging two weak banks is not going to create a strong one. Similarly, merging one strong and one weak bank is a not going to create a stronger entity,” said Karthik Srinivasan, group head of financial sector ratings at ICRA Ltd. Srinivasan added that resolution of stressed assets should be a precursor to bank mergers.

Comments from the rating agencies come at a time when the government has said that it will assess more public sector bank mergers this year. Last year, State Bank of India (SBI) merged with its five remaining associate banks. In an interview to Bloomberg News on Wednesday, Finance Minister Arun Jaitley said that the government would be contemplating a few more bank mergers following the merger of SBI with its associates.

“I think the merger itself will only strengthen Indian banks, it won’t weaken the capacity of the banks to support growth,” said Jaitley.

According to Alka Anbarasu, vice president and senior analyst at Moody’s, consolidation might be a good medium to long term solution for the sector, as it would make it easier to manage fewer banks, ensure corporate governance and give banks more power in lending consortia. However, there are no near term positives that emerge from consolidation.

If anything, the solution that is needed for these banks is the capital solution. If the government provides adequate capital when these banks are being merged then it may resolve or postpone the problem.
Alka Anbarasu, Vice President and Senior Analyst, Moody’s Investors Service

Capital Woes For Banks

Moody’s believes that the public sector banks, which it rates, would need anything between Rs 70,000-95,000 crore worth capital over the next two years. However, the ability of these banks to raise such a high amount of capital from the market is severely limited due to low valuations.

According to Anbarasu, under current conditions, the banks would have to depend on their biggest shareholder, the government. However, the government’s budgeted Rs 20,000 crore in financial years 2017-18 and 2018-19 would be inadequate, she said while adding that many banks are now in dire need of capital.

Since the government is yet to announce any increase in the budget for recapitalisation, there is a lack of policy clarity, she added.

Resolving Bad Loans

Meanwhile, the bad loan problem may continue to build, albeit at a slower pace. ICRA, in its review, pointed out that 86 percent of fresh bad loans generated in fiscal 2017 came from outside the pool of restructured loans. This suggests new sources of banking stress are continuing to emerge.

We estimate the fresh NPA (non performing assets) generation at 5.5 percent for FY17 as compared to 6 percent for FY16 while the overall stressed assets for the banking system is estimated around 16-17 percent as on March 2017.
Karthik Srinivasan, Group Head - Financial Sector Ratings, ICRA 

The regulator’s involvement in stress resolution after the government’s ordinance last month could prove to be beneficial for the banking sector, Srinivasan told BloombergQuint.

Even though banks have had multiple tools available, resolution has been slow because banks have failed to reach a consensus or are unable to take deep haircuts. To help speed up resolution, the Banking Regulation Act has been amended to allow the RBI to intervene directly in bad loan resolution. The regulator is currently in the process of setting up an advisory committee and expanding an existing oversight committee to help with the resolution process.

According to Srinivasan, while the interference from a regulator is undesirable, it is likely that banks will now be pushed into resolving these accounts more quickly.