The BIC’S time to resolve recap issues is now
Banks are among the most leveraged entities. The Basel Committee norms permit a leverage of 33 times. Ironically, this ability to leverage comes from the strength provided by the capital of a bank. No doubt, in times of stress, any entity will find it difficult to raise equity; in the case of banks, however, it is even more difficult, given the need for the larger investors to meet the fit and proper criteria. It is for these reasons that the Reserve Bank of India (RBI) has been insisting on and off on the need for banks to raise capital well in advance.
The RBI’S Report on the Trend and Progress of Banking in India for 2019-20 (RTP) estimates an additional capital requirement of 150 basis points of common equity tier-1 capital. Even assuming that the distribution of required incremental capital among bank groups is linear, the additional capital needed works out to about ~81,693 crore on risk weighted assets (CRAR) of ~54.46 trillion in FY2019-20.
The latest Financial Stability Report of the RBI projects a decline in system-level CRAR to the extent of 1.6 percentage points under baseline assumptions. The decline in CRAR and the consequent additional capital requirements for state-run banks as a class will likely be higher in view of the elevated incremental levels of NPAS projected for them.
The estimation of expected slippages is rendered even more difficult because of the uncertainties of how the withdrawal of the pandemic-related regulatory forbearances will play out. There is no gainsaying the fact that it is a large amount of money, and all the more so when there are several competing areas requiring fiscal support as the economy emerges from the debilitating effects of the pandemic. With the budgeted capitalisation for this year, the total recapitalisation has been of the order of ~3.16 trillion in the last five years.
Let us see the impact of banks being inadequately capitalised. In the first place, the ability of these banks to increase their credit portfolio will be severely constrained. Secondly, after one of the private sector banks ran into financial difficulties, state-run banks turned safe havens, resulting in a spurt in their deposit growth, particularly term deposits. An endogenous credit squeeze on account of balance-sheet constraints of banks would have greater macroeconomic dimensions.
At some point, the leverage ratio can constrain a few banks’ ability to even invest in government securities. In the context of uncertainties about the future trajectory of NPAS when recognition norms return to the pre-pandemic framework, one has to think medium- to- long-term, rather than just the immediate future. A Bank Investment Company (BIC) can play a pivotal role.
The BIC can raise equity to the extent that it is still majorly held by the government. So long as the BIC holds more than 50 per cent, the government’s control over state-run banks as the majority shareholder of the BIC remains. This implies that the government will be the majority shareholder while in effect having invested only about 26 per cent of the equity of the bank. (Effectively, government funds invested in a bank would be 51 per cent of the 51 per cent held by the BIC.)
It renders future privatisation easier. All that the government needs to do is to divest a part of the BIC’S equity in the specific bank which the government intends to privatise. Second, the BIC can be used as the entity for handling all governance and strategy-related matters. Eventually, the government can bring state-run banks under the Companies Act and extend all the provisions of the Banking Regulation Act.