The Rush for capital: Why are banks raising capital?

With this piece, we try to understand why a few of the most reputed banks are currently raising capital – and what the implications of this.. banks raising capital, banks raising capital, banks raising capital, banks raising capital

In the past few months, several banks have been rushing to raise capital, as if it were a new fad in India Inc. However, common sense tells us that it isn’t. Just as we, the commoners, stack-up cash during uncertain times, banks too need some capital to protect themselves against any uncertain event that may occur.

BankAmount (₹ Crore)Status
Yes Bank15,000Concluded
Kotak Mahindra Bank7,400Concluded
IndusInd Bank3,500Planned
IDFC First2,000Concluded
ICICI Bank15,000Concluded
HDFC Bank50,000Planned
Federal Bank4,000Planned
Axis Bank15,000₹10,000 Cr raised
SBI25,000₹ 8,931 Cr raised
Bank of Baroda13,500₹764 Cr raised
Canara Bank8,000Planned
PNB10,000Planned
Amounts raised by banks: Planned vs raised, as of August 24, 2020

But maybe, not all of us know the business sense behind it and to understand the same, keep reading.

The COVID-19 Impact: Banks raising capital

We have spent more than four months with the COVID-19 pandemic. It hasn’t been easy for us, and for businesses, it has been worse. The lockdown imposed to curb the spread of pandemic forced businesses to stop operations, several people lost jobs and many MSMEs are on the brink of shutting down permanently. With almost nil revenues during the lockdown, unlocking was expected to be the ray of hope for businesses, but low demand and supply chain disruptions have roughened the revival route. Now what does this have to with banks, you may wonder, but any impact on the economy always affects the banking sector.

Businesses borrow from banks for working capital needs, capacity expansion plans and various other obligations. Whereas, individuals borrow from banks to buy a house, a car and even for education. Due to lockdown and job losses, many businesses and individuals may not be able to repay their outstanding principal and interest.

We know that banks earn through the interest they receive, therefore, the net interest margin of banks will be impacted. However, the damage doesn’t stop there. A bank is supposed to keep aside a certain percentage of the amount that it lends as a provision in case the borrower fails to repay. So, if a bank has given out a loan of ₹1000 crore, and the borrower hasn’t paid either the interest or principal for less than 90 days consecutively and has availed the moratorium, then the bank is required to keep aside 10% of the loan amount as provisions, for the March 2020 and June 2020 quarters, as directed by the RBI. In this case, the bank will have to keep aside ₹100 crores from its own capital.

Erosion of Capital

The provision norms become stricter for loans that are classified as non-performing assets (NPAs), obliging banks to keep aside more capital. These provisions made by the banks are treated as expenses. So, higher the NPAs, higher the provisioning and higher the provisioning, higher the expenses and lower the interest income, resulting in losses for the bank. Now, we know that the net profit is added to reserves and surplus in the balance sheet. So, adding a negative net profit (loss) basically erodes off the equity capital.

When that happens, the bank’s financial stability is jeopardized. The RBI mandates banks to maintain a Capital Adequacy Ratio (CAR) of 9%. The CAR is the ratio of a bank’s capital to its risk-weighted assets (loans). Erosion of capital decreases the CAR of a bank. Consequently, investors perceive the bank as risky and customers lose confidence in it. All of this further poses a threat to the bank’s survival. Remember the Yes Bank crisis? That is what may follow.

According to various estimates, the gross NPAs are likely to increase to 11-12% at the end of this financial year from 8.6% at the end of FY20. Given this possibility, banks are rushing to raise capital to avoid all the consequences that could arise as mentioned above. Raising capital will help banks build resilience against the rise in NPAs by keeping their financials relatively stable. Another reason for the same could be to ensure that enough capital is available to lend once the economy revives and credit flow improves.

Author

The piece was written by Shivam Ghule, we hope you now understand why banks are raising capital. If you liked the piece, go ahead and share it with your best buddy on WhatsApp 🙂

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