Public sector banks' solvency position worsens

With most public sector banks (PSBs) reporting a sharp increase in net non-performing assets (NPAs), the solvency position of these lenders has deteriorated rapidly over the past three quarters.

A Business Standard analysis of 19 state-owned banks shows that at the aggregate level, the solvency

ratio (ratio of a bank's net NPA to its net worth) has edged up to 45.3 per cent at the end of the third quarter, from 35.8 per cent at the end of the first quarter in the current financial year. This means that 45.3 per cent of the net worth of these 19 banks would be wiped off if they had to provide for these bad loans.

"In good times, the solvency ratio was 15-20 per cent. But now, for most PSBs, it is of a much higher magnitude," says Vibha Batra, group head of financial sector ratings at Icra.

Among the larger banks, Punjab National Bank appears to be in an extremely precarious financial position. Its solvency ratio worsened from 38.7 per cent in the first quarter to a staggering 54.5 per cent at the end of the third quarter. By comparison, State Bank of India is in a relatively better position with its solvency ratio deteriorating from 21.7 per cent to only 28.2 per cent.

With a sharp rise in NPAs, the solvency ratio for Indian Overseas Bank (IOB) deteriorated sharply from 76.3 per cent at the end of the first quarter to 101.4 per cent in the third quarter, implying that the bank cannot even provide for all the bad loans on its books. Other public-sector banks have also witnessed large slippages. Bank of India's solvency ratio swelled from 56.3 per cent to 71.8 per cent over the same period, while Central Bank of India's ratio went up to 65.9 per cent from 47 per cent.

"The results indicate a sharp deterioration in the financial health of public-sector banks. The overall stress among public sector-banks is very high. While these banks have seen deterioration in performance in the past few years, the extent of losses being reported now is very high," says Anuj Jain of CARE Ratings.

While most banks saw their solvency position worsen, a few managed to buck the trend. These include State Bank of Bikaner, State Bank of Travancore, United Bank, Jammu & Kashmir Bank, and Punjab & Sind Bank, which have actually managed to lower their solvency ratios.

This sharp rise in NPAs is the consequence of Reserve Bank of India (RBI) exerting pressure on banks to recognise bad loans quickly. But, given the level of opacity in the system, it's difficult to gauge how bad things really are.

To get a better of sense of what could potentially be the actual extent of bad loans in the system, analysts at CRISIL suggest using an alternate estimate. "The right number to look at is weak assets. Our estimate of weak assets stood at Rs 5.5 lakh crore, against the current gross NPAs of around Rs 3.5 lakh crore (at the end of September 2015)," says Pawan Agrawal, chief analytical officer at CRISIL Ratings.

"As you keep recognising more NPAs, the gap between the two numbers (Rs 5.5 lakh crore and Rs 3.5 lakh crore) will get bridged," he adds. As banks would not have made provisions for these assets, the financial position of public sector banks is likely to worsen in the coming quarters. Batra believes most banks will spread higher NPA recognition over the coming two quarters.

With bad loans piling up, it is becoming abundantly clear that banks' Tier-1 capital will need to be strengthened quite significantly. Although the government infused capital in some PSBs last year, the amount was a pittance compared to what is needed to recapitalise banks. Take the case of the IOB. Last year, the government infused roughly Rs 2,000 crore of capital in the bank. But, with the bank reporting losses worth Rs 550 crore and Rs 1,425 crore in the second quarter and third quarter of the current financial year, respectively, the capital infused was barely enough to compensate for the losses.

While analysts had earlier estimated that public sector banks would need around Rs 3.4 lakh crore of capital to meet the Basel-III norms, the sharp deterioration in asset quality suggests the figure would need to be revised upwards. "As the asset quality is deteriorating at a much faster pace than anticipated this number is likely to be revised upwards," says Agrawal.

But, this is where the situation gets complicated. The recent stock market rout suggests investors are deeply sceptical about the financial prospects of public sector banks. The market is currently valuing all public sector banks at almost the same level as one private bank - HDFC. In fact, investors so sceptical that the country's largest bank SBI now has a market capitalisation equal to that of the much smaller Kotak Mahindra Bank.

This suggests most public-sector banks will find it difficult to raise money directly through markets and will be dependent on government funding. But, given that the Centre's fiscal space will be constrained by outflows on account of the Seventh Pay Commission and the One Rank One Pension scheme, finding money to capitalise banks is going to be challenging.