Banking sector’s capital dilemma puts investors at bay

Banks may like to raise more capital from their stock holders citing constantly updated regulatory requirements and to fund their ambitious growth plans but at a return as little as 10 or 11 percent, not many will be willing to risk their money.

This is roughly the return the investors in the banking sector receive, not much higher than what an investor of a one-year treasury bill gets.

The banking sector return on equity (RoE), a widely used performance indicator to measure the return generated on the shareholder funds in the banking sector, has recently been feeling the downward pressure due to the constantly increasing capital needs, which fail to generate equally higher profits.

Hence, the shareholders remain on the edge for a while thinking if the banking sector stocks could beat the returns from other sectors such as consumer or healthcare or power and energy, which seem to have more upside than the rest in 
today’s context.

According to the published results, almost all licensed commercial banks (LCBs) reported lower RoEs in 2018 from 2017 from between 17 basis points to 262 
basis points.

Meanwhile, the industry average RoE, which captures licensed special banks (LSB), has fallen by 440 basis points to 13.2 percent in 2018, from 17.6 percent in 2017.

This developing scenario could hurt the investor appetite on the banking sector, said Pan Asia Bank in its future outlook of the sector as part of its annual review of operations.

“Given the declining shareholder return from the banking sector, we like to think that it would be an uphill task for the banks to remain attractive towards both existing and potential shareholders,”  it stated.

According to Fitch Ratings, Sri Lankan banks have raised a mammoth Rs.50 billion and Rs.24 billion in fresh capital – in both equity and debt – in 2017 and 2018, respectively in the run up to the full implementation of BASEL III capital rules.

The banks continue to raise equity during this year as well.

Sampath Bank has already announced a rights issue to raise Rs.12.1 billion to beef up its Tier I capital base to enable lending of otherwise could come under stress. 

The Central Bank also required all licensed commercial banks to double their minimum core capital level to Rs.20 billion by end-2020 – roughly a year from now.

“In any case, ever increasing regulatory capital requirements will force the banks to make capital calls from their shareholders in order to remain in business but the question remains how low the RoE should fall before the stockowners start saying, ‘enough is enough’,” the annual report added.