BANK RECAPITALIZATION: ENHANCING CAPITAL BASE

Source: Yojana – January 2018

Author: Ashutosh Kumar

The load of non-performing assets (NPAs) on the public sector banks (PSBs) has been adversely affecting their lending capability, which in turn is hindering private investment and private sector gross capital formation. NPAs in PSBs have grown to Rs. 7.33 crore in June 2017 increasing by three times in two years approximately. NPAs of domestic banks have reached about 10% of loans and advances recently.

To deal with the problem, the Union Cabinet recently announced the elaborate Rs. 2.11 lakh crore recapitalization plan to revitalize domestic banks. The breakup of the recapitalization plan is thus:

1. 18,000 crore from budgetary support;
2. 58,000 crore from equity issuance;
3. 1, 35,000 crore from bank recapitalisation bonds.

The case of recapitalization bonds:

The recapitalization bonds (or ‘bonds’) are going to be front loaded i.e. a large chunk of total Rs. 1, 35,000 crore will be pumped into the banking system in the next few months itself.

In all likelihood, the government will issue the bonds and banks will subscribe the instrument directly. The sovereign money will not move out and it will simply be an accounting entry thus preventing the government from an additional fiscal burden.

This measure is going to be beneficial for the banks as it would enhance their capital base. Moreover, in case the government allows the banks to trade the bonds in the secondary market, it will help them raise money further. On the flip side, if banks are not allowed to sell the bonds in the secondary market, it can serve as investments earning interest incomes and therefore is beneficial for the banks in both cases.

The recapitalisation of banks can also be gauged from the angle of Insolvency and Bankruptcy Code. The code is being used for the resolution of about 300 accounts. Owing to such huge amount of NPAs, the banks may have to take haircuts to the tune of Rs. 2,40,000 crore or 60% in case of resolution of 50 large stressed accounts as per a CRISIL report. The sector which accounts for largest amount of debt is the metals sector (30%) followed by construction sector (25%) and power (15%). These sectors also account for almost half of the total NPAs in the economy. The power sector would require moderate haircuts while the construction and metal sector would need aggressive haircuts.

Owing to the requirement of such haircuts and for meeting the BASEL III norms, PSBs do require infusion from the government as the government is the biggest stakeholder and therefore the recapitalization of banks is a step in the right direction.

At the same time, it must also be considered that the annual interest cost of the bonds is likely to be in the range of Rs. 8000 crore to Rs. 9000 crores, which, as per the Chief Economic Adviser Mr. Aravind Subramanian is not going to either result in inflation, nor push fiscal deficit because of increased economic activities and asset creation.

The issue of recapitalization bonds has also to be accompanied with wide ranging banking sector reforms.