Private banks may get to take pref route for funds
With Basel II migration coming closer, government may amend Banking Regulation Act to help banks improve their CAR.
By Preeti R Iyer, TNN |
Private sector banks may soon be allowed to raise capital through issue of preference shares, given that the government is now working on an amendment to the Banking Regulation Act.
Although the Reserve Bank of India (RBI) has already issued guidelines for banks intending to issue preference shares, this route was not available to private banks, due to a specific section of the Banking Regulation Act.
The Centre is now working on legalities to allow even banks in the private sector to tap this route, said Pavan Kumar Bansal, the minister of state for finance told bankers at a forum on microfinance and Basel II norms in Mumbai last week.
Preference shares enable banks to improve their capital adequacy ratio without diluting equity. This, incidentally, comes at a time when private sector players such as ICICI Bank, ING Vysya Bank and Centurion Bank of Punjab have almost reached the limit as far as foreign investment is concerned.
According to Ernst and Young director Viren Mehta, this will be profitable for banks if they are able to raise capital through this route, at a cost cheaper than the debt route, considering that these would be paper with a longer-tenor. It���s likely that banks would be allowed to issue redeemable preference shares and not the convertible ones.���With the deadline for adherence to Basel-II norms just a year away, banks, especially ones with a foreign presence, will also have to look at ways of improving their capital base.
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In its mid-term monetary and credit policy statement released in October 2006, RBI asked foreign banks operating in India and Indian banks having presence outside India to migrate to the Basel II standards with effect from March 31, 2008.ICICI Bank CFO Vishakha Mulye explained that the capital treatment of preference shares will have to be treated on par with equity capital and not debt issues. Cost of raising equity ranges anywhere between 15-20%. From an issuer perspective, pricing would be more favourable as investors are more secure because preference shares are treated on par with senior debt outstanding of a bank.
Hence, this lowers the chances of coupons getting forfeited. From a subscriber���s view, market sources feel that creation of an appetite may take some time before it really takes off among investors. Coupled with that, banks choosing this route need to cough up a dividend distribution tax of only 10%.
Investors may also see more fruition in investing in such issues since the dividend earned is tax-free. Hence, on a tax-adjusted basis, preference shares will be a more attractive proposition for investors as against hybrid Tier-I issuances.
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Typically, as per current market conditions, banks offer anywhere between 140-145 basis points over and above the London Inter-Bank Offer Rate on hybrid Tier-I debt issuances. Furthermore, it will also come in handy for those players keen on building their books for scouting opportunities for consolidation purposes. Union finance minister P Chidambaram has urged banks on several occasions to initiate activities of consolidation, with a view that a few large players would be more suited to face global competitive forces compared to many small- and mid-sized banks.
In the recent past, the banking industry has seen Centurion Bank take over two banks, Bank of Punjab and Lord Krishna Bank, while South-based Federal Bank moved to take over Ganesh Bank of Kurundwad. More recently, ICICI Bank has secured approval from its board of directors to take over the ailing Maharashtra-based Sangli Bank.
In July 2006, RBI decided to allow banks to augment their capital funds by issue of innovative perpetual debt instruments (IPDIs) eligible for inclusion as Tier-1 capital and debt capital instruments qualifying for upper Tier-II capital.
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