BACK FROM THE BRINK
THE Rs 2 LAKH CRORE-PLUS BANK RECAPITALISATION PACKAGE WAS A NECESSARY FIRST STEP TO LIFT THE ECONOMY OUT OF THE DOLDRUMS
ON OCTOBER 24, THE CENTRAL GOVERNMENT administered a major shot in the arm of ailing public sector banks by announcing a Rs 2.11 lakh crore bank recapitalisation plan. The package included Rs 1.35 lakh crore via bank recapitalisation bonds to be issued to these banks and Rs 76,000 crore from budgetary support and market loans.
With the economy reeling under the twin effects of demonetisation and the Goods and Services Tax (GST), dragging down growth to 5.7 per cent in the first quarter, all eyes were on the government and how it would tackle this. Apart from banks, the Centre has also announced a road-building programme to build 83,000 kilometres of highways with an investment of nearly Rs 7 lakh crore over the next five years. This is expected to create 142 million man days by 2022. “Macroeconomic fundamentals are strong; the government has decided on the steps needed to sustain the growth momentum,” Union finance minister Arun Jaitley said, while announcing the plans in Delhi.
The biggest need for Indian banking was recapitalisation, or infusion of funds into the system, so that there is more money available to lend. While credit offtake hit bottom in the past few
months—a reluctant private sector has stayed off big-ticket investments— revival will require fresh lending by the banks, especially public sector banks (PSBs), which comprise over 70 per cent of the Indian banking system. Credit offtake to all segments, including industry, agriculture, services, personal and housing loans, fell to a historic low of 3.3 per cent in February this year. The need to recapitalise banks has become all the more important as they are saddled with huge non-performing assets (NPAs) or bad loans. The total bad loans of 38 listed commercial banks crossed Rs 8 lakh crore at the end of the June quarter, nearly 11 per cent of the total loans disbursed by the banking industry (see graphic). A lion’s share (90 per cent) has been racked up by the PSBs.
Experts say the recapitalisation move sends a strong signal of support to public sector banks from the government. “The package will help public sector banks accelerate provisioning for stressed assets, speed up the NPA resolution process and support the clean-up of balance sheets,” says Krishnan Sitaraman, senior director with Crisil Ratings. “This will help them focus on reviving credit growth.” These banks needed Rs 1.4-1.7 lakh crore additional capital to meet Basel III requirements by March 2019, so the package is adequate, he adds.
BAD LOANS TRAP
The State Bank of India (SBI) accounted for the largest share, about 22.7 per cent (Rs 1,88,068 crore) of the Rs 8,29,338 crore total of NPAs of 38 banks as of June-end 2017, accoring to Care Ratings data. SBI, Punjab National Bank, Bank of India, IDBI Bank and Bank of Baroda accounted for 47.4 per cent (Rs 3,93,154 crore) of
total NPAs as of June-end 2017.
The huge pile of NPAs of PSBs has undermined their health in many ways. For one, they have shrunk exposure to their biggest areas in corporate lending—steel, infrastructure and real estate—where they have burnt their fingers. Besides, banks now have to provision for these NPAs in their books, further eroding profitability. The new Insolvency and Bankruptcy Code, 2016, though touted as a big clean-up act in banking, has come a cropper. When a defaulter is referred for insolvency under the new laws, negotiations with lenders through an insolvency professional will see banks agreeing to take a ‘haircut’ or settle for a payment much lower than they had originally lent.
Crisil estimates banks may have to take a haircut of up to 60 per cent— amounting to Rs 2.4 lakh crore—to settle 50 large stressed assets with a total outstanding of Rs 4 lakh crore. These companies are from the metals, construction and power sectors, and account for half of the total NPAs. Power companies would require moderate haircuts, metals and construction firms would need aggressive ones. In most cases, asset sales will recover monies.
“Currently, PSBs are fine when it comes to the capital adequacy ratio, since there is not much demand for credit. But this will change,” says Madan Sabnavis, chief economist with Care Ratings. Capital adequacy ratio is a measure of a bank’s capital expressed as a percentage of its credit exposures. The economy is stagnating, and without the demand for credit, the system is in a kind of stasis. “But if there is a recovery, banks will have to be the natural preference for borrowers.” Many borrowers would find it difficult to approach the market for funds as they may not be investment grade (credit rating for funds regarded as carrying minimal risk to investors).
BASEL III DEADLINE
Indian banks will need $90 billion of capital by 2019 to meet the new Basel III capital norms, to be implemented by the financial year ending March 2019. Basel III is a global, voluntary regulatory framework on aspects related to the health of banks, including capital adequacy and market liquidity risk. “The sharp rise in non-performing loans and the resultant losses have weakened banks’ core capital buffers, which will be further stretched when adjusted for a higher 70 per cent provision cover on problem loans,” Saswata Guha and Jobin Jacob, analysts of ratings agency Fitch, observe in a report. “Liability ratings will be under more pressure if capital levels are not addressed, either by the government or by the market.”
The government had earlier allocated Rs 10,000 crore in Budget 2017-18 to recapitalise banks, while the earlier two fiscals saw Rs 25,000 crore allocations. The original idea was to provide Rs 70,000 crore to PSBs over four years, according to reports. Jaitley recently conceded that recovering money from the big defaulters is a “major challenge”. “For the first time, the government is taking steps to take these big people to insolvency so that recovery can be done and that money can be utilised for the growth of the rural sector,” he said in September. Moreover, the process of resolution will be slow and likely to be challenged in courts, as has happened in the case of Essar Steel. This will entail, besides substantial capital infusion for the PSBs, measures like sale of non-core assets, raising of public equity and divestments by the government.
MERGING FOR SIZE
Another idea mooted is the merger of banks to create bigger banks that have the potential to raise more capital from the market. But experts say the merger of weak banks does not address the issue of their performance. The same is true in the merger of a weak bank with a strong one. “If I combine a loss-making bank with a strong bank, I will have camouflaged the weak bank but, overall, the losses have to be taken by the system,” says Sabnavis. Divestment can also run into trouble as the valuations of PSBs have taken a beating in the stock markets. The recent move by SBI to merge five of its associate banks and Bharatiya Mahila Bank with itself has worked because most of these associate banks had sound financial health.
Others believe banks ought to approach the market, and not just wait for succour from the government. The concept of recapitalisation is not new. A recapitalisation boost was given to Indian PSBs in 2009 following the global financial crisis. Countries such as Indonesia have even successfully experimented with the concept of a ‘bad bank’ (after the Asian crisis of 1997), into which all the bad assets of commercial banks are channelled, so that the banks can be recapitalised for growth.
RBI governor Urjit Patel had called for a recapitalisation of PSBs as they are not, he said, healthy enough for big ‘haircuts’. “Gross NPA ratio of the banking system at 9.6 per cent and stressed advances ratio at 12 per cent, as on March 2017, on the back of persistently high ratio in the past few years, is a matter of concern,” he had said.
Creating fundamentally strong banks is essential for India’s long-term growth, and resolving NPAs is crucial for this. Even as the resolution process is on, the recapitalisation boost to the banking sector is expected to give it a fresh lease of life.
“SOMETIMES MAJOR REFORMS BRING MINOR HICCUPS, BUT IN THE MID AND LONG TERMS, THESE PROVE TO BE FAR MORE BENEFICIAL.” ARUN JAITLEY Union minister for finance