Presentation on resource mobilisation by Ranjit Sinha

NEED FOR LONG TERM RESOURCES

FOR BANKBY CHAMPION GROUP:-PRIYAMVADA AJAY KUMARSTANISLAUS I AGERARANJIT KUMAR SINHAHITESH R THANTHARATEATUL KUMAR SRIVASTAVA

Long Term Sources are those that are needed over a longer period of time - generally over a year The reasons for needing long term resources are generally different to those relating to short term resources. long term resources may be needed to fund expansion programme of bank It may be required for setting up new branches, subsidiaries etc. It may be required for developing and launching new products It is very important to note that in most cases Bank will not use just one source but a number of long term sources.

Long Term Sources are used for modernisation, expansion, diversification. It is required to cater Asset Liability mismatch, Interest Rate Risk, liquidity risk

Authorised, Issued, Subscribed and Paid up capital Par/face value, Issue Price, Book value and Market Value Rights of equity shareholders

-Right to Income :PAT less preferred dividends

-Right to Control: voting rights-Pre-emptive Right: for additional issues,

rights issue in the same proportion -Right in liquidation: residual claim over assets

Advantages• No fixed maturity, no obligation to redeem• No compulsion to pay dividendsProvides leverage capacity• Dividends tax exempt for investors

DisadvantagesDilution of control of

existing ownersHigh Cost: rate of return

expected by equity holders higher than debtholders

Dividends are not tax deductible: hence cost is higher

Issue costs higher: underwriting, brokerage, other issue expenses

Higher servicing costs: hold AGMs, post annual reports etc.

ProsReadily available, no talking to outsidersEffectively additional equity capital, however no issue costs of loss due to underpricingNo dilution of controlNo expansion in equity base, hence no dilution of EPS, BV per share etc.

ConsQuantum very

limitedHigh

Opportunity costs: dividends forgone by equity holders

Requires careful attention to NPV of projects

Is a hybrid form of financing, payment after debt but before equityEquity features: -out of distributable profits -not an obligatory payment -dividends not tax deductibleDebt features: -dividend rate is fixed -capital is redeemable -normally no right to voteCan have other features like cumulative, convertible, participating…..

ProsNo obligation to pay dividend, no bankruptcy or legal action for non paymentFinancial distress of redemption obligation not very highPart of net worth, hence increases its creditworthiness/ leverage capacityNo dilution of controlNo pledging of assets required

ConsExpensive source

since dividends not tax deductible

Though no legal consequences, liability to pay dividends stands, can spoil company’s image

Can acquire voting rights in some cases

Have claim prior to equity holders

Like promissory notes, are instruments for raising LT debt

More flexible compared to term loans as they offer variety of choices as regards maturity, interest rate, security, repayment and other special features

Interest rate can be fixed/floating/deep discount

Convertibility : Can be FCDs, NCDs, PCDs

Warrants : Can have warrants attached, detachable or non detachable, detachable traded separately

Option : Can be with call or put optionRedemption: Bullet payment or redeemed in instalmentsSecurity: Secured or unsecuredCredit rating: Need to have a credit rating by a credit rating agencyTrustee: Need to appoint a trustee to ensure fulfilment of contractual obligations by companyDRR: Company needs to create a DRR if maturity more than 18 months

Initial Public Offer (IPO) Secondary Public offer Rights Issue Bought out deals Euro Issues Private Placement Preferential allotment Venture Capital/ Private Equity transactions

Pros Access to larger amount of funds Further growth limited companies not using this route Listing: provides exit route to promoters; ensures marketability of existing shares Encash on value created in the firm Recognition in market Stock prices provide useful indicators to management Sometimes stipulated by private investors in the company

ConsPricing may have

to be attractive to lure investors

Loss of flexibilityHigher

accountabilityMore disclosure

requirements to be met

Visibility in marketCost of making a

public issue quite high

Eligibility criteria defined: net worth, track record of profitability, issue in same year; secondary issues have no such restrictionsBook Building process: process of tendering quantities at prices within a bandIssue expenses: underwriting, brokerage commissions, fees to managers to the issue, registrars, printers, advertisers, listing fees, stamp dutyIssue pricing: free pricing, disclose basis for issue pricePublic issue of debt: appointment of debenture trustee, creation of DRR, credit rating reqd., security to be created

• Issue of capital to existing shareholders• Offer made on a pro rata basis• Offer document called Letter of Offer• Option given to apply for additional shares• Rights renunciation: are tradeable, may be

sold off in the market• Comparison with Public issue: with familiar

investors, hence likely to be more successful; less floatation costs since no underwriting; but lower pricing to benefit shareholders

Sale of securities directly to wholesale investors like FIs, banks, MFs, FIIs,PE funds etc.

Called private placement in equity/equity related instruments, in unlisted companies and in all cases of debt

Called preferential allotment in case of unlisted companies for equity/equity related instruments

Different from reservations made for such QIBs out of a public issue

Subject to SEBI regulations on pricing, lock in period, open offer to be made to public

QIB placement guidelines recently issued by SEBI for compliance and disclosures

ProsLess expensive modeLesser SEBI and other regulationsEasier to market the issue to a few investorsEntry of wholesale financially sophisticated investors in company’s profileMay use this route until IPO decision takenLess administrative maintenance

ConsDoes not qualify

for listing in an unlisted company

Restrictive covenants may be imposed by the investors

May call for management participation

Issue pricing more tight

Equity finance to potentially high growth companies Reasonably long to medium term commitmentHands on management approach, active participation in managementConsidered value add investorVC: primarily high risk high return investment esp. in technology oriented/ knowledge intensive businesses with long development cycles, greenfield venturesCan be in unlisted or listed (PIPES) CompaniesExit route to be defined at the time of investmentRestrictive clauses on promoters’ holding sell off and other financial/operational issuesDetailed memorandum/business plan on company, its financials to be preparedShareholders agreement to be signed by both partiesValuation of Company key issueLeads to dilution of control by existing promoters

The Indian economy has witnessed robust growth performance in recent years and banks have played a major role in providing the required amount of resources. In order to sustain the growth process, banks would have to continue to provide funding on a large scale. In India, there exists an enormous potential of savings in rural and semi-urban areas. Also, quite a large part of domestic savings is locked up in unproductive physical assets. The mobilisation of savings from hitherto untapped areas and conversion of physical savings into financial savings would necessitate introduction of appropriate products to suit the demand of savers. Banks are indeed in an ideal position to do so because of certain inherent characteristics of deposits such as safety and liquidity.

Apart from mobilisation of deposits, banks, for meeting their resource needs, also depend on non-deposit resources both at home and abroad. A part of non-deposit resources comes from borrowings, which help augment the funding needs of the banks instantly. However, they also pose a challenge in terms of their availability and management of borrowing costs, amidst potential interest rate and exchange rate risks.

Bank deposits have all along been the mainstay of the savings process in the Indian economy. Although banks have played an increasingly important role in stepping up the financial savings rate, physical savings, nevertheless, have tended to grow in tandem with the financial savings. A major challenge, thus, is to convert unproductive physical savings into financial savings. This is also necessary for banks as they face several challenges in realising the full potential of deposit mobilisation in a growing economy. Bank deposits have become relatively less attractive to the households in view of the availability of a wide menu of alternative saving instruments offering scope of higher returns to savers. Furthermore, savers have also become more informed in managing risks of their portfolios through the use of specialised services offered by other financial intermediaries. This behaviour is expected to accentuate in future. In view of the shrinking share of the household sector deposits in total deposits, banks need to explore ways of broadening the depositor base as also provide improved services for retaining their clientele. It is, therefore, necessary for banks to seek for new sources/alternate resources.

Since bank nationalisation, banking in India has become increasingly politicised. Non-performing assets have become worse since recent past. There is already an expectation of yet another write-off of loans by a government desperate to improve its image after being riddled with scams and scandals.

It is important to have strong capital base for a bank to survive in times of distress. If there is a run on a bank, only strong capital base of a bank can bail it out of difficulties. This is because, while deposits are repayable immediately, assets take time to be materialised and collected. The history of financial crises, including the one of 2007-09, is littered with cases where many banks having low capital base, faced insolvency or financial difficulties serious enough to warrant state support.

At the time of distress only strong bank having large capital base can sustain.

Bank also require long term resources to fulfill the gap caused by Asset Liability mismatch.

As BASEL III regulation progressively kick in, the amount of capital needed to keep the banking system running is multiplied.

It has increased pressure for infusion of fresh capital, one of major long term resources.

As the BASEL III guidelines are progressing, almost all the systems capital requirement for BASEL III transition will be due in coming years (2016-18) and additional buffers for Capital Conservation and for India`s yet to be identified “systematically important banks” will also kick in.

Today`s banking is Capital intensive. For every Rupees that is lent out by a Bank it has to set aside 23 paise in low interest earning Government Securities. Another 3 paise is to be set aside to meet Regulatory Cash Reserve Ratio requirements.

Within the balance amount, Banks must also meet Priority Sector guidelines that is upto 40% of credit.

With the balance amount free for Lending to Indian Companies and Individuals at market determined rates.

The real problem arises when loans begin to turn sour. It must be provided for bank non performing loans as they age over time and fully provided for once they turn from sub - standard to loss over a period of two years.

Capital Adequacy Ratio of Indian Public Sector Banks have been severally hit due to falling profitability and rising NPAs.

Most of the public sector banks are at the bottom of pile when it comes to meeting RBI`s Capital Adequacy requirements.

India Ratings have estimated that Capital requirements in 2014-15 for Indian Banks will be modest but demand for Tier I Capital will accelerate sharply from 2016.

Total Capital requirements for BASEL III transition will be around Rs. 520000 Crore for the entire sector.

Of this Common Equity is expected to constitute Rs.230000 crores, Tier I Hybrid Bonds Rs.170000 crores and Tier II Subordinate Debts Rs.120000 Crores.

Out of above govt banks will require 80% of the amount.

India Ratings projections assume additional buffers above minimum requirements of 1.5% for the five largest bank and a buffer of 0.5% for all other banks.

For the above requirements Banks shall have to regularly tap the Equity Market as well as Overseas for long term resources in the form of fresh capital.

One of the other options to bring resources is by way of selling shares to LIC.

One of the other sources is by way of placing BASEL III Hybrid Bonds.

Any Questions ?

THANK YOUTHANK YOU