In late 2015, when the Reserve Bank of India (RBI) undertook a ‘deep-surgery’ of the banking sector, some setback was anticipated. But the magnitude of the bad loan muck caught the regulator, the government and market watchers off guard. From a mere Rs 2.75 lakh crore in March, 2015, bad loans peaked to over Rs 10 lakh crore in March, 2018, putting lenders and borrowers on the edge. But the most unsettled among them all was the government, which owns 21 lenders accounting for over 70 per cent of the country’s banking assets.
Reason: Though pulling out non-performing assets (NPA) from under the carpet was considered good, stringent provisioning norms wiped off banks’ profitability, accentuating the need for additional capital. In fact, until late last year, even the extent of the bad loan pile and the capital needs of Public Sector Banks (PSB) was unclear. For instance, the seven-point Indradanush plan rolled out in 2015 estimated PSBs’ capital needs at Rs 1.8 lakh crore, to be raised over four years until 2019. However, this number jumped to Rs 2.11 lakh crore in January, 2018 and the government was forced to fork out more, straining its finances and the fiscal math.
The bad news is that the worse isn’t yet over, as experts fear more NPAs will likely tumble out of the closet. “We do expect a flare-up in NPL formation in Q3FY19/Q4FY19 because of IL&FS defaults and/or any mishap in the developer portfolio,” noted Moody’s Equities Analysts’ Nilanjan Karfa and Harshit Toshniwal. However, they believe, this could be offset through upgrades or recoveries of say, power or steel accounts.
Meanwhile, as part of the Indradanush plan, the government was to infuse Rs 70,000 crore and the balance was to be raised by banks. But unlike their private peers, PSBs weren’t as successful in raising capital from the market. Consequently, PSBs were dependent on the government to bail them out, even if it meant nationalizing losses with taxpayers money — exactly what banking rules were meant to stop! As a majority shareholder, the government needed to keep its commitment in order to strengthen balance sheets, hoping that it would attract private capital at better valuations in the future.
So in January 2018, the government front-loaded another bank recapitalisation plan aggregating Rs 2.11 lakh crore for FY18 and FY19, to be done through budgetary provisions, recapitalisation bonds and raising capital from the market. The additional capital buffers were expected to enhance banks’ ability to raise equity capital. But despite the substantial capital infusion, the capital to risk-weighted assets ratio is an area of concern, according to Care Ratings. Worryingly, it also noted that additional provisioning for NPAs, possible losses from restructured assets, and other weak assets could further erode capital and raise requirements for additional capital in the coming years.
Experts feel, along with capital, what is needed are banking reforms that can bring in discipline and credit culture among state-run lenders. Keeping this in view, the government did put in riders while infusing capital, which of course was given based only on performance — including reduction of NPAs and improved capital ratios. For instance, banks were expected to set up specialised monitoring cells to oversee all loans above Rs 250 crore. This would be accompanied by a stressed asset management division, ensuring recovery and follow-up. The current capital allocation is based on capital ratios and NPA levels, and banks’ ability to absorb credit losses from operations.
While stronger banks are receiving higher capital, weaker banks are being shown some tough love, subjecting them to prompt corrective action, which prevents them from being in business as usual.
Plan B
Now that the NPA time bomb has exploded, nursing PSBs back to health is crucial. However, given resources are limited, lenders may have to explore all options available. A look:Private capital
State-run banks can raise private capital, which will help share the government’s burden. But for that to happen, valuations should be fair and proper, which is what the balance sheet clean up exercise was originally aimed at executing. Roping in private investors is also expected to not only improve the performance of these lenders, but also ensure compliance with best practices
Sell assets
Almost all public sector banks have several non-core assets and a part or complete stake sale in subsidiaries like insurance JVs, market-making divisions and foreign branches could provide emergency capital. RBI deputy governor Viral Acharya even suggested that the valuable and sizable deposit franchises be sold off to private entities, so that they can operate as healthy entities rather than be in intensive care under PCA.
Privatisation
This isn’t entirely new, with successive governments toying with divestment in PSBs up to 52 per cent. The NDA government, however, took the first steps, asking the Cabinet Committee on Economic Affairs and the Union Cabinet to separately authorize an Alternative Mechanism to facilitate divestment last year.
Mergers
Often considered the default option, given that there was no need for the government to run 21 PSBs. However, the idea stopped in its tracks, as finding synergies is quite a challenge, unlike merging SBI with associate banks. Nevertheless, the Centre began another experiment to merge one relatively strong, but small bank (Vijaya Bank) with one sick and weak bank (Dena Bank and Bank of Baroda). Perhaps, more could follow based on the outcome.