Focus To Shift From Capital Adequacy To Operating Earnings For State-Owned Banks

The Government, in a very bold and decisive move, has underwritten both the regulatory capital and growth capital needs of the state-owned banks. This capital infusion will be made over the two financial years, FY 18 and FY 19. The move ensures adherence to the Basel 3 norms for banks that were required to be met by March 2019.

The first important aspect of this move is for PSU Banks that had been placed in the PCA (Prompt Corrective Action) framework by RBI thereby restricting them from lending to higher risk weight assets. As a result, these banks were losing significant market share to private sector banks and NBFCs. This trend is now expected to moderate.

The second aspect is that the better capitalised PSU banks that did not face lending restrictions will now step up credit growth with the benefit of increased growth capital at their disposal.

PSU banks in both the above categories: PCA and PCA exempt, will now have enough capital to increase the provision coverage and thus will be better prepared to withstand hair cuts in case of NCLT led resolutions. Proactively as well, many of these banks are likely to approach ARCs (Asset Reconstruction Companies) to sell down NPAs. This will also be better for scaling up of large ARCs.

The process of re-rating of many of the PSU Banks has thus well begun with an expansion in their price to book multiples. We would, of course, maintain a very selective approach towards these banks as only a few have demonstrated a reasonable level of risk-controlled lending in the past. The structural issues at many of these banks will continue to remain a challenge and thus we are quite conscious of the need to differentiate the better-managed lenders from the rest.

We are in the middle of an exciting Q2 earnings season and the reality of elevated asset quality stress is set to dawn upon the market in a few days from now. Overall, the move is extremely positive in a directional sense since more details of the recapitalisation bonds have not yet been announced. We continue to believe that some banks will be better placed to take advantage of this opportunity than others.


Nikhil Johri

Nikhil Johri
Founder & Chief Investment Officer