* Capital plunge may trigger bail-in of subordinated creditors
* Move would test assumptions of state support for Indian banks
* Problems over application of Basel rules to state-owned lenders
By Manju Dalal
SINGAPORE, Feb 14 (IFR) - A worsening capital crisis at one of India’s smaller state-owned lenders is setting the scene for Asia’s first test of regulators’ attitudes towards subordinated bank capital.
Kolkata-based United Bank of India last year became the first Indian bank to issue loss-absorbing securities, often dubbed “bail-in bonds”, to supplement its regulatory capital under the Basel III regime.
Mounting credit losses have left UBI’s capital ratios dangerously low, and Fitch Ratings warned this week that UBI’s common equity tier 1 and Additional Tier 1 ratios may fall below 5% for the full financial year ending in March.
Analysts are expecting the government to bail out the bank, but the treatment of UBI’s subordinated creditors will offer the first hint at how regulators in one of Asia’s biggest emerging markets plan to interpret Basel III rules.
The Reserve Bank of India, like many other Asian regulators, has not clearly defined the point at which it will force sub debt holders to take losses, as required under the terms of Basel III, but it has the power to do so on the Tier 2 bonds UBI issued last year.
Declaring the bank to be no longer viable would trigger Asia’s first bail-in of subordinated bank debt.
Such a move would offer an indication of the RBI’s attitude towards the Basel III regime, hinting at India’s commitment to enforcing the new global standards. In India’s largely state-owned financial sector, however, it poses a dilemma.
No state-owned Indian bank has ever been allowed to fail, giving rise to a belief that state ownership implies a moral obligation on the government to support public sector banks.
That suggests the fall-out from triggering the loss-absorption clause on UBI’s bonds would lead to a swathe of downgrades in the country and to higher funding costs for India’s already capital-strained banks.
Adding to the complication, UBI’s loss-absorbing sub debt is held by state-owned Life Insurance Corp of India, the sole investor in UBI’s Rs5bn (US$80m) placement of Tier 2 bonds last year.
“The RBI is truly in a dilemma. If the central bank does not bail out UBI, people will be screaming blue murder and if it does, this decision will encourage investors to buy riskier paper (of state-owned banks),” said a Mumbai-based DCM banker.
On February 7, UBI reported a net loss of Rs16.8bn for the nine months ending December, down from a Rs3.6bn profit in the same period the previous year. UBI’s gross non-performing assets ratio increased to 10.8% in December, up sharply from 5.6% in June last year.
The losses have brought UBI’s current total capital ratio to 9.01%, within a whisker of the minimum 9% requirement.
Worse, its Tier 1 ratio has dropped to 5.6%, below the RBI’s minimum common equity tier 1 requirement of 6.5% and below the 6.125% level that would trigger loss-absorption clauses on Additional Tier 1 instruments under the new regulatory framework in India.
As a result of its losses, UBI will be barred from paying a coupon on the Rs5bn of Basel III-compliant Tier 2 bonds it sold to LIC, and may be forced to write down those instruments in full if the RBI declares the bank to be no longer viable.
Market participants seem divided on what route the RBI should take.
“The RBI has an opportunity to set a precedent in the light of Basel III. Options are limited as one can either choose to bail-out hybrid debt investors or allow loss-absorbing instruments to take losses first which is also consistent with the Basel III approach,” said Saswata Guha, an analyst at Fitch Ratings.
“In fact, whichever step the central bank takes in the light of Basel norms, it will give clarity to investors at a time when Indian banks are planning US dollar Basel III-compliant offerings,” Guha said.
Others, however, caution that triggering the loss-absorption clause would send shockwaves through the Indian financial system as investors are forced to reassess their expectations of state support.
Forcing subordinated creditors to take losses would call into question the approach of rating agencies such as Crisil, which have assigned high ratings to loss-absorbing bonds in India on the premise that the RBI will not allow a state-owned bank to fail.
In its June 13, 2013 release assigning UBI’s Rs5bn new-style Tier 2 bonds an AA+ rating, Crisil said: “A robust regulatory and supervisory framework and systemic importance of the banking sector is expected to ensure adequate and timely intervention by RBI to avoid a situation wherein a bank becomes non-viable.”
Icra and Crisil each cut their ratings of UBI’s sub debt this week, but kept them at investment-grade ratings.
Ultimately, though, RBI may find a solution that does not trigger a write-down. UBI has already received Rs7bn from the government in the current financial year, without any talk of non-viability, while in October, the Indian Government announced a capital infusion of Rs140bn in 20 state-run banks by the end of March.
India’s banking secretary Rajiv Takru said on Wednesday that the government may consider injecting additional capital into UBI. Analysts said the bank will require at least Rs5bn in the current quarter to stay afloat.
According to the RBI, Indian banks will need to raise Rs5trn by March 2018 to become fully compliant with Basel III requirements. Of this, nearly Rs1.75trn will come through equity capital and the remainder in the form of Additional Tier 1 and Tier 2 securities. (Reporting By Manju Dalal; editing by Christopher Langner and Steve Garton)