Indian banks may need to raise up to US$50bn of additional equity under the Basel III capital regulations announced by the Reserve Bank of India, on top of retained earnings. Most of the requirement is back-ended - with over 75% needed to be added between FY16 (financial year ended March 2016) and FY18. The additional equity reflects growth capital as well as a buffer above the regulatory minimum.

The guidelines released on 2 May 2012 do not yet provide for a counter-cyclical capital buffer or additional capital for systemically important banks. Fitch's calculations add half a percentage point of additional common equity to the regulatory minimum, which banks may like to maintain to avoid breaching the conservation buffer - with attendant restrictions on dividends and other payouts.

The immediate impact of the Basel III capital regime is benign, with the common equity Tier 1 ratio for many Indian banks already close to 8% or higher. However, the shortfall mounts up between FY16 and FY18, mostly for government banks - with loan growth outpacing internal capital generation, and the minimum capital ratios stepping up. The largest requirement is by State Bank of India and its associate banks, reflecting their significant share in the banking system; followed by the mid-sized and small government banks with weaker internal capital generation. The large private banks fare better, due to their higher capital ratios and stronger profitability.

About half of the US$40bn needed by government banks is likely to be injected by the government based on its stated intent of maintaining majority shareholding. Government's support has been boosted since 2008, and it has budgeted for a USD2.5bn injection of equity in FY13. The requirement will however accelerate in FY16 - and needs to be planned.

Similarly, the remaining equity of up to US$20bn that may need to be raised from the markets represents a significant addition for banks. To put this in perspective, Indian banks raised only about USD2.5bn of common equity from the markets in FY11 and FY12 combined. Unless planned, government banks may face the risk of a sudden shortfall in capital during FY16, requiring additional support by the sovereign and putting further pressure on government finances.

The need for fresh capital comes at a time when the performance of Indian banks is clearly being affected by the economic slowdown, together with asset-quality pressures from concentrated exposure to infrastructure companies and weak state-owned entities. The Viability Ratings (the standalone financial ratings) of some government banks may be downgraded unless these pressures ease, though their IDRs should remain unaffected at the Support Rating Floor - due to expectations of continued support from government.

ICRA Note on Basel III Guidelines