Moody's Investors Service today said the government's plan to provide more capital support to public sector banks in current fiscal will restore capital adequacy and improve loan-loss coverage at many loss-making banks, but stress will persist.

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The government plans to provide Rs 65,000 crore of new capital for public sector banks (PSBs) in the year ending March 2019 (fiscal 2019) after infusing Rs 90,000 crore in the prior year. Of the Rs 65,000 crore, the government allocated Rs 11,300 crore to five banks in July.

"The large-scale recapitalisation plan, which was meant to improve capital buffers and loan-loss reserves and also support sufficiently strong loan growth, will now be just enough to shore up capital ratios above regulatory requirements because the banks' capital shortfalls have grown larger than the government's initial projection," said Alka Anbarasu, a Moody's Vice President and Senior Credit Officer.

Moody's said the PSBs' external capital needs will not grow much further after fiscal 2019 because the banks' profitability will gradually improve as credit costs moderate in tandem with progress in an ongoing balance-sheet cleanup.

"Our analysis shows that the capital injections will only be enough to enable all the banks to achieve Common Equity Tier 1 (CET1) ratios of at least 8 per cent by March 2019, satisfying the 2.5 per cent conservation buffer on top of the 5.5 per cent minimum under Basel III norms in India and giving the banks a capitalisation profile comparable to those of their similarly rated peers globally," Anbarasu said.

In a report 'Banks - India: Government aid will give capital relief to public sector banks but stress will remain', Moody's said to maintain capital buffers at regulatory levels, the banks will have to keep loan growth modest, at 5-6 per cent. "This means the government has little choice but to increase capital support if it seeks faster loan growth to support economic expansion," Anbarasu said.

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Moreover, while the capital injections will enable the banks to strengthen their provision coverage, it may still not be sufficient if they take large write-downs on the non-performing loans (NPLs) they sell as part of new resolution proceedings. An increase in provisions could raise their capital needs significantly.

Although the government support will help the public sector banks build up their capital and provisioning buffers against losses, the improvements are likely to prove only temporary, barring a broader reform to fundamentally strengthen their weak underwriting practices, the rating agency said.

"Without reform, the government will continue to have to inject capital into the banks when they face stress, which will strain its own finances and hinder its efforts for fiscal consolidation," it added.