Link to Fitch Ratings' Report: Indian Banks: Applying Fitch's Criteria on Basel III Capital Instruments

Fitch Ratings-Mumbai-23 August 2013: Fitch Ratings says in its special report that the anchor rating of Basel III compliant gone-concern (Tier 2) capital instruments issued by Indian banks will differ between systemically important government-owned banks, and other banks. For going-concern Basel III additional Tier 1 instruments the anchor rating for notching will be the Viability Rating (VR) for all banks.

For select Indian banks, Fitch believes there is a strong case to factor in extraordinary support for Tier 2 securities on the basis of historically strong government linkages, systemic importance and the absence of a clear resolution framework. In these cases the anchor rating will be the higher of the VR or the support-driven Issuer Default Rating to reflect the agency's view that the point-of-non-viability (PONV) is unlikely to be triggered. The likelihood of such support will be limited to only few issuers where the risk of contagion is considered to be extremely high. Even for government banks which control more than 70% of the system assets, state support, if needed, may be selective. This is because depositors and senior unsecured creditors, which are higher on the capital structure, will likely be protected first.

In the case of additional Tier 1 instruments no extraordinary support is factored in as non-performance can be triggered before PONV is reached and will be "permanently" written down before injection of public capital is considered. Fitch expects Basel III Tier 1 instruments to be written down for banks under stress irrespective of size and systemic importance, resulting in the VR being the appropriate anchor for the rating of such instruments.

Basel III additional Tier 1 instruments will be typically notched five levels from the VR to reflect the greater risk of non-performance than Basel III Tier 2, in the form of fully discretionary coupon suspension (three notches), and loss severity (two notches).

For Basel III Tier 2 securities, Fitch will notch down by one level for loss severity where recoveries on instruments are expected to be below-average. Notching will likely be widened to two if the write-off is viewed to be permanent and full. However, under both Tier 2 and additional Tier 1, the notching will be narrower if the relevant anchor rating is 'BB+' or 'bb+', or lower due to rating compression; even so base case notching will be at least one level from the relevant anchor rating.

Fitch's treatment of Basel III-compliant securities issued by Indian banks is in line with its criteria titled "Assigning and Rating Bank Subordinated and Hybrid Securities", and takes into account the domestic legislative framework specific to India as well as the authorities' historically supportive nature.

The special report titled, "Indian Banks: Applying Fitch's Criteria on Basel III Capital Instruments", is available at www.fitchratings.com or by clicking on the link above.