An employee of Muthoot Finance Ltd., counts Indian one hundred rupee banknotes (Photographer: Anindito Mukherjee/Bloomberg)

Scheduled Commercial Banks May Need Rs 89,000 Crore Provisioning Under Ind-AS

Scheduled commercial banks (SCBs) may need up to Rs 89,000 crore towards incremental provisioning for advances while transiting to the Indian Accounting Standards (Ind-AS) 109 regime, says India Ratings and Research.

Of this, public sector banks would need Rs 63,100 crore, which is equivalent to an equity write-down of 1.10 percent of the banks’ risk weighted assets and 11.5 percent of net worth at end-March 2017. Private sector banks would also need a whopping Rs 25,800 crore; however, their higher capitalisation would enable a smooth transition.

The provisioning required for migration to Ind-AS along with asset quality overhang and Basel III transition would surge capital consumption by banks especially PSBs. India Ratings, however, believes that staggering the provisioning requirement for the migration to Ind-AS 109 could reduce the intensity of the potential impact.

Assumptions

The agency’s study assumes a lifetime probability of default of 15 percent and 100 percent for stage 2 and stage 3 assets, respectively. Also, India Ratings estimates a possible blended haircut of around 50 percent across stressed assets. The current study assumes a loss given default (LGD) of 50 percent for all assets across stage 2 and stage 3. The agency’s calculation of restructured assets include all categories of standard restructured assets including 5/25, S4A and SDR.

The study includes the additional provision requirement in stage 2 on account of SMA2 exposure across the banking sector and additional provisioning on account of standard restructured advances in stage 3.

Additional provisioning requirement assumes 15 percent provisioning already set aside by banks. This is on account of banks providing higher for select standard restructured assets post the Reserve Bank of India’s asset quality review and annual divergence exercise. The agency excludes the provisioning requirement on non-performing assets (NPA) exposure which form a part of stage 3 assets, given the current provision on NPAs is close to 50 percent which is the expected LGD across sectors.

Provisions To Follow A Steep Curve

India Ratings assesses the provisioning requirement for stage 2 assets to be significantly higher at 7.5 percent of gross advances than 0.4 percent under existing Indian GAAP accounting for most of the assets in the SMA2 category. The regulatory requirement of provisions on standard restructured assets is set at a minimum of 5 percent which again maps significantly lower than what is anticipated under the new regime.

India Ratings believes a significant increase in provisioning in the new regime may necessitate reduction in risk weights in select asset categories to make a judicious balance between the existing and Ind-AS framework.

Headwinds Under Ind-AS To Knock Down Growth Aspirations

In October 2017, the government of India announced a direct recapitalisation of Rs 1,53,000 crore in PSBs. Assuming Ind-AS is implemented from April. 1, close to 41 percent of announced recapitalisation funds would be consumed towards incremental provisioning requirements, putting pressure on PSB’s ability to meet the regulatory core equity tier 1 capital under Basel III framework.

This could increase the pace of portfolio churn and credit market shift towards private sector banks, and partly towards wholesale non-banking finance companies. PSBs’ loan growth increased to 8 percent year-on-year at end-September 2017.

Additionally, India Ratings believes PSBs’ capital consumption to remain high, given that profit and loss accounts (P&L) for most of banks (especially mid-size PSBs) would remain under pressure due to the accelerated provisioning requirement on the accounts identified by the regulator for reference to the National Company Law Tribunal under the Insolvency and Bankruptcy Code in the current fiscal.

As per India Ratings’ estimates, the quantum of the government’s proposed capital injection in PSBs, together with the banks’ proposed mobilisation of capital, should largely cover the provisioning shortfall for their stressed assets.

The capital can also support modest growth in advances. India Ratings estimates additional equity would be required if the credit demand were to pick up, though it does not form the base case scenario in view of the large idle capacity in the system.

APAC Scenario

As per a survey conducted by Fitch Rating Ltd, only Chinese banks listed in Hong Kong are likely to implement IFRS 9 in 2018, whereas Thailand aims to implement in 2019, Indonesia and Mongolia are targeting 2019-2020.

Impact On Ratings

India Ratings’ outlook towards the standalone profile of PSBs (especially mid-size) remains negative due to the possible additional provisioning burden that could surge their capital requirements.

The impact on large PSBs and private sector banks remains limited, given their better capitalisation levels and superior ability (better market valuation) to raise capital from the market.

India Ratings and Research, a wholly owned subsidiary of Fitch Group, is a SEBI and RBI accredited credit rating agency operating in the Indian credit market.