"Public sector banks would depend more on equity injections from the government, as their capital ratios could be impacted by falling internal accruals together with pressure to grow the loan portfolio," India Ratings and Research said in a report.
The government and Life Insurance Corporation of India injected about 95 percent of equity into these banks between FY10 and FY13. This year the government will infuse Rs 14,000 crore in state-owned banks.
"Clearly, the government is trying to balance between managing the fiscal deficit as well as maintain confidence in its banks that control over 70 percent of system assets," the report said.
The report said the situation has deteriorated rapidly for weak banks, such as Central Bank of India, United Bank of India whose Q2 FY14 quarterly losses on account of rising non performing assets, were equivalent to about 10 percent of their equity.
"In our base case scenario, the government's peak annual contribution to banks' equity remains under 1 percent of GDP under the Basel III regime till March 2018. This is manageable but needs to be planned to avoid any pile-up towards the end," the report said.
The rating agency considers the Basel III guidelines announced by RBI as a credit positive for Indian banks and any dilution in the guidelines may be counterproductive if viewed by the markets as a sign of systemic weakness.
Banks' deteriorating performance also brings the role ofhybrid debt capital in absorbing losses under focus, the report said.
"The market for Basel III Tier 2 instrument is fledging in India and investors will benefit if the Reserve Bank of India (RBI) articulates a framework for invoking losses on the holders of this instrument," the report said.
The report, however, said while banks will remain dependent on the government for capital support, the role of the hybrid capital instruments may come under scrutiny.
According to the report, since these instruments provide an additional tool for preserving banks' capital, a regulatory clarification on invoking losses, for example, defining the framework for identifying the points of non-viability for Tier 2 instruments, will be helpful in developing this market.


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