India's state-owned banks' plans to raise capital from private sources will not be sufficient to mitigate the anticipated risks unless supplemented with additional capital support from the Centre, Fitch Ratings said on Monday.
The assessment comes after several large state banks have recently announced plans to raise a total of around $6 billion in fresh equity from the capital market.
"State banks already face significant execution risks in raising equity due to depressed stock market valuations and weak investor interest," Fitch Ratings said in a statement.
Besides, the ratings agency cited a recent report that indicated the government' s plan to reduce the number of state banks to five from 12, while selling majority stakes in several others, including Bank of India to raise resources.
"A reduction in the state's majority shareholding in some of its banks may dent depositor confidence and potentially lead to negative rating action as their long-term ratings are anchored to state support," the statement said.
"It may also reduce investor appetite at a time when government capital support has stuttered, and an acceleration in new coronavirus cases is hampering a meaningful economic recovery and increasing risks for banks' balance sheets."
According to Fitch, the proposed stake sales will be "very challenging" in the current economic climate and in light of the potential capital shortfalls "we calculate at the state banks in our stress test."
"It could also require amendments to the banking company acts, which currently prescribe a minimum government shareholding of 51 per cent for the state banks, thus adding to execution risk," the statement said.
The ratings agency expects state banks will remain reliant on fresh equity injections from the Centre as the proposed capital amounts, if raised fully, will likely add only around 100-150 bp to banks' existing common equity a Tier 1' (CET1) ratios.
"Under our high stress scenario, this may provide some interim capital relief, testing the banks' ability to raise fresh equity on their own, but will not be enough to stave off heightened solvency risks. It would also increase the prospect of further regulatory forbearance."
As per the statement, recapitalisation requirements might be substantially higher once pandemic-related asset quality deterioration starts manifesting on bank balance sheets when regulatory forbearance ends, in which case raisin equity from the market will be more difficult.
"Recent comments by the central bank governor highlighting the need for recapitalisation further underscores this imperative, emphasising the risks that deteriorating asset quality will pose to state banks' limited capital and earnings buffers," the statement said.
"This is consistent with the outcome of our stress test on individual banks, whereby the state banks have significantly larger capital shortfalls than their private counterparts."