Short-cut on bank recap

P&SB's zero-coupon bonds violate prudent accounting practices

The government’s move to issue Rs 5,500 crore in zero-coupon bonds towards the recapitalisation of Punjab and Sind Bank (P&SB) has put the nearly three-decade-old process under the spotlight. As far as innovations go, even the interest-bearing recapitalisation bonds were unique to begin with. The Centre subscribes to a state-run bank’s preferential capital, and the proceeds are invested by the bank in interest-bearing bonds in a cash-neutral transaction and the entries are matched. Few other regulatory jurisdictions where there is a preponderance of state-run banks have opted for this mode to infuse capital. The move to opt for zero-coupon recapitalisation bonds is an acknowledgement that the Centre has very little fiscal headroom. Even more so after the pandemic, given the competing interests for a shrinking pool of government revenues.

While these are systemic issues, what is more worrisome is that the accounting treatment accorded to P&SB’s zero-coupon bonds is in contravention of well-established prudent practices. Five non-interest bearing securities maturing on December 14 between 2030 and 2035 were issued to P&SB, but the nature of these instruments is such that P&SB gets to have Rs 5,500 crore only on their maturity. The bank has to show the investments at a discount in its held-to-maturity portfolio, and not at the face value of Rs 5,550 crore. It would call for a markdown on the equity infused in the bank lower from Rs 5,500 crore as the entries have to match. And to that extent, the Centre may have to rethink its fiscal maths if it is to use the instrument for recapitalisation. The very fact that the authorities deemed fit to pursue the kind of creative accounting which has been accorded to P&SB’s bonds may be interpreted as desperation setting in. The short point is that equity cannot be created out of thin air; it comes at a price which has to be borne by the promoter-shareholder: In this case, the government.

The bigger picture is irrespective of whether interest-bearing or zero-coupon bonds are issued, the incidence of servicing the interest cannot be avoided — in the latter case, it is merely deferred. It is also likely that P&SB’s zero-coupon bonds may have to be suitably restructured. The low valuations of state-run banks also make it difficult for them to tap the market. Between 2015-16 and 2019-20, the Centre had pumped in Rs 3.56 trillion into these banks through both direct subscription of equity shares and recapitalisation bonds. Their market capitalisation stands a tad above Rs 4 trillion, or 13.48 per cent more than the sum infused over the past five years. It was well below what was infused for much of this period. In the case of specific state-run banks, it is much lower than the amounts infused. In any case, recapitalisation bonds give a misleading picture of the health of these banks — the net profit has to be adjusted for the interest income earned on the bonds.

Thus, recapitalisation is stuck on two counts — very little fiscal headroom and the fact that valuations of these banks are low. In many cases, the government’s stake in them is well above 80 per cent if the Life Insurance Corporation of India’s stake is also taken into account. While privatisation remains an option, the current low valuations of these banks make it unattractive. A way out is to fast-track the Bank Investment Company (BIC) model. This will allow the government to get returns upfront; and more later when it cuts its stake — in the BIC itself, or when the BIC does so in individual state-run banks. Of course, it calls for simultaneous governance changes as well — a tweak in the capital structure in itself does not lead to the betterment of valuations. Time is of the essence from here on, as the recapitalisation route may not be feasible for too long.