f o r    m a n a g i n g    t o m o r r o w
NOV. 20, 2005
 Cover Story
 BT Special
 Back of the Book

Retail Conundrum
The entry of foreign players, and FDI, could galvanise the retail sector and provide employment to thousands. Left parties, however, feel it would push small domestic players out of jobs. What is the real picture?

The Foreign Hand
Huge spikes and corrections in the BSE Sensex have lately come to be associated with the infusion and withdrawal of capital from foreign institutional investors (FIIs). Are India's stock markets becoming over dependent on FIIs?
More Net Specials
Business Today,  November 6, 2005
Dash For Cash
With non-food credit growing at two times the rate of deposits, fuelled by burgeoning demand for housing and personal loans, banks are scrambling to beef up their capital base.

The auditorium of the National Centre for Performing Arts (NCPA) in south Mumbai is often host to theatrical productions that range from the traditional to the experimental. In August, the hall was the venue for what you would normally assume to be an event completely bereft of comedy, tragedy, history or experiment-the annual general meeting (AGM) of the Indian Banks' Association (IBA). Also present at the AGM, along with the assorted head honchos of India's premier banks, was Finance Minister P. Chidambaram. Not totally unpredictably, the theatrical environs of the AGM setting prevailed over the lack of a dramatic air at the AGM, prompting the FM to hark back to a bit of Shakespearean melodrama. Picking out a couplet from Henry VI, Part II, Chidambaram thundered: "Ignorance is the curse of God; Knowledge is the wing wherewith we fly to heaven." Even as the front rows packed with by-now baffled bank ceos pondered the provocation for this rather cryptic tempest, the minister duly set out to rephrase the good bard of Avon: "Inaction is the curse of God; action is the wing wherewith we fly to heaven."

It may have been a rather drastic method of conveying a pithy message to the banking community, but it seems to have worked well enough. For, the industry is indeed in action mode, at least on the capital-raising front. Consider: ICICI Bank is expected to hit the US and domestic markets in December with a mega-issue of Rs 7,000 crore-the largest ever equity offering, second only to ONGC's 10,000 crore offer last year. Other banks too have hopped on the capital-raising wagon: Kotak Bank plans to raise a little over Rs 300 crore, Union Bank of India will mobilise Rs 600 crore, and Bank of Baroda has plans to mop up Rs 1,600 crore. The list is long (see It's Raining Equity Offerings), with most of these banks taking the plunge in a bid to raise their tier-I equity capital (banks' capital comprises two tiers, tier I and tier II. Tier I is the core capital consisting of equity capital, reserves and surpluses, while tier II refers to debt capital).

"People are reallocating their savings between financial and physical instruments like housing, vehicles, etc."

Executive Director/ICICI Bank
"Banks are resorting to disposing of the surplus G-sec stock in exchange for cash to meet the growing credit demand"

CMD/Union Bank of India

Even without Chidambaram's exhortations, bank CEOs would have had their compulsions for rushing to the markets, the biggest one being the lag between bank deposits and banks' non-food credit: Whilst the former grew by 15 per cent in 2005, non-food credit was up by twice that figure. How do bankers explain this phenomenon? "We have seen people reallocating their savings between financial and physical assets like housing, vehicles etc.," reasons Chanda Kochhar, Executive Director at ICICI Bank. G.V. Nageswara Rao, CEO (Commercial Banking), IDBI Ltd, explains that a part of household savings is gradually moving into capital markets, mutual funds and high-yielding post office deposits.

To top it, many banks' existing capital has been severely hit in the past by the reversal in the interest rate cycle. This resulted in massive losses in the treasury books of some of the banks, leading to erosion of capital. Rajesh Mokashi, Executive Director at ratings agency Care Ltd, believes that any upward movement in interest rates on the back of inflationary pressure will continue to impact the tier-I capital of banks since many banks are still holding G-Secs under the sale category. Points out K. Cherian Varghese, CMD, Union Bank of India: "Banks are resorting to disposing of the surplus G-sec stock in exchange for cash to meet the growing credit demand." RBI statistics bear this out. In a recent report, the apex bank observes: "The banks' G-Sec holdings have fallen below 36 per cent in September 2005 from a high of 40 per cent a year ago, but still is above the 25 per cent statutory requirement."

If commercial banks today need dollops of capital, it's also because credit growth is expected to remain healthy in future, with aggressive demand coming from housing, real estate and personal loans. "Corporate lending is also gradually picking up," adds A.K. Khandelwal, CMD of Bank of Baroda. According to the Central Statistical Organisation, GDP is pegged at 8.1 per cent for the first quarter of 2005-06 and the RBI's assessment is for improved growth prospects for the rest of the year.

Apart from meeting the credit demand from industry, banks will have to prepare themselves to smoothly migrate to the Basel II regime in the next one and a half years. As per these norms, Indian banks will have to make provisions for additional capital requirement to cover operational as well as market risk. Chidambaram has already gone on record saying post-Basel II the banking sector may see a net depletion of 200 basis points in capital adequacy. Currently, all banks have to maintain a minimum capital adequacy ratio of 9 per cent, meaning a bank has to bring in Rs 9 from its capital for every Rs 100 extended as loan. The twin effect of credit growth and Basel II is sending every commercial bank to Bond Street to raise subordinated debt issues that qualify for tier-II capital. But there is a limit to which banks can raise tier-II capital as the maximum amount is restricted to 50 per cent of the tier-I capital.

Even as India's premier banks storm the equity markets for tier-I capital and the debt markets for the second tier, there are some banks that are unfortunately not placed that well to join the party. In the case of public sector banks like Dena Bank, Bank of India and Andhra Bank, an equity dilution would result in government holding slipping below the 51 per cent threshold limit. For example, the government holding in Dena Bank is currently at 51.19 per cent, which prevents the bank from raising equity or subordinate debt.

Kotak Bank (Managing Director Uday Kotak seen in picture) intends to raise Rs 300 crore from its IPO

Of course, there are those lucky few that don't feel the need to raise any capital. Not yet, anyway. "Why raise equity? Barring the investment fluctuation reserve, our entire capital is tier-I. We might look at raising tier-II capital next year," says V.K. Chopra, CMD, Corporation Bank. The newly-christened IDBI Ltd too doesn't require capital as it has a comfortable capital adequacy of over 15 per cent. But these are by far the exceptions and for most Indian banks, equity seems to be the only option to raise more capital and meet the Basel II norms. In fact, the RBI too is trying to temporarily solve the capital adequacy issue, by allowing the investment fluctuation reserve (IFR, a reserve that a bank is required to create to cushion itself against interest rate fluctuations that could affect its investment portfolios) to be treated as a part of tier-I capital.

Bankers are also eagerly awaiting action on the FM's Union Budget 2005-06 proposal of allowing banks to issue preference shares without voting rights. Currently, this policy is awaiting parliamentary approval. If this proposal comes through, banks with low government shareholding (between 51 and 60 per cent) can raise capital without diluting the government stake.

In the meantime, rating agency Care Ltd has mooted a unique 'gold share' concept, which carries veto rights on major decisions. "The government could relinquish majority ownership in the PSU banks, but can still retain requisite control over it," explains Mokashi of Care Ltd. In fact, the golden share has been used extensively in privatisations in Malaysia, Singapore, Britain and numerous other countries.

For the time being, though, the capital market as well as overseas borrowings are the two wide avenues open for banks. But it remains to be seen how long this tap remains open in the light of rising interest rates globally and a dwindling domestic capital market. Then again, as long as those windows are open, banks shouldn't be wasting too much time worrying about the longer term. The fm could well have added another quote from Henry VI in his speech at the IBA AGM. "Defer no time, delays have dangerous ends."

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