A bank bailout or a clever boost to growth?
The Government of India’s move to recapitalise public sector banks has triggered a debate — is the move a mere bailout for government-owned banks or an attempt to boost flagging economic growth with an improved credit growth?
Morgan Stanley has cheekily referred it to as India’s Tarp — a reference to the US Troubled Asset Relief Programme, through which the US government purchased toxic assets and equity from financial institutions to strengthen its financial sector following the aftermath of global financial crisis
“A proper recapitalisation will help banks to recognise NPL’s [non-performing loans] and make adequate provisions for them as well. The banks can take the required hits, make proper provisions, and move ahead. The insolvency code was helping NPL resolution — now this will accelerate,” the bank said in a note.
According to Morgan Stanley, the biggest beneficiary of the move on a sustained basis will be State Bank of India (SBI).
Public sector lenders were sitting on a bad loan pile of Rs7 trillion (Dh396 billion) as of June and this would have swelled further as of September.
Barring a handful of lenders, the provision coverage ratio of most banks skims around 50 per cent and that leaves a huge chunk of toxic loans uncovered.
Rating agency Moody’s expects all rated public sector banks to get enough capital to satisfy their Basel III capital requirements as well as adequately address their asset quality challenges. Thus, while the extent of improvement may vary, the agency expects the capitalisation profiles of all rated public sector banks to improve.
The banks have been suffering the after-effects of a wave of exuberant lending over much of the past decade to companies in sectors such as steel and infrastructure, many of which failed to achieve the forecast returns and failed to meet their loan obligations. Gross non-performing loans at the state-controlled lenders hit 13.7 per cent of assets at the end of June, up from 5.4 per cent in March 2015.
“The quantum of the plan is large enough to comprehensively address these banks’ weak capitalisation levels,” wrote Srikanth Vadlamani at rating agency Moody’s in a recent note.
Governance reforms
For the recapitalisation plan to deliver durable economic growth, banks must also undergo governance reforms. Repeated bailouts are unlikely to bode well for the banking system and the economy. Government therefore needs to carry out reforms, which should begin with allowing bank boards and senior management more autonomy and greater scrutiny of lending practices of these banks.
Analysts say the infusion of funds into banks is likely to have little impact on the government’s plan to stick to the target of maintaining the budget deficit to 3.2 per cent of gross domestic product in the year through March 2018 because the International Monetary Fund’s rules classify such debt as ‘below-theline’ financing.
Only interest expense will be added to the fiscal deficit, and this is estimated at about Rs90 billion each year or 0.4 per cent per cent of total budgeted spending. Technically, however, India’s accounting rules require the bonds to be included in the budget deficit, so the government will probably reclassify them later as off-balance sheet items.