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It was one of those routine Budget meetings in Yojana Bhawan last winter when Planning Commission mandarins decided that an injection of Rs 11,200 crore from the government would be adequate to meet the expansion plans of state-owned banks in 2014-15. All hell broke loose at Jeevan Deep, a building barely 350 meters away where the banking department of the finance ministry is located, as the word got around. It had estimated that 27 public sector banks (PSBs) would require capital infusion of Rs 45,528 crore during the year. Given the urgent need for fiscal consolidation, it had thought of providing about Rs 20,000 crore, while asking the banks to raise the remaining funds from markets and other routes.
Officers rushed to the budget division in the finance ministry at North Block to press for a higher allocation for PSBs reeling under stressed assets. "The Planning Commission decided on it in a meeting where we were not present. By the time we took up the matter with the budget division, the documents had gone for printing. They said the provision was just for the interim budget and additional money could be provided in the full budget (to be presented by the Narendra Modi government in July)," says a finance ministry official.
Not enough for all needs
But even if their demand is met, it is doubtful the money will be enough. PSBs are sitting on a huge pile of bad assets and much of the new capital will go into writing them off. Last year, PSBs wrote off non-performing assets (NPAs) worth Rs 25,311 crore. According to estimates, assuming average annual growth of 20 per cent in their loan books, PSBs will need Rs 8 lakh crore over the next five years to fully meet the forthcoming Basel-III norms - the global standard to improve regulation, supervision and risk management - by March 2019. (They will need Rs 5 lakh crore if their loan book grows 15 per cent.) Under the current Basel II norms, the Reserve Bank of India (RBI) has stipulated capital adequacy ratio (proportion of bank's capital against its advances) of 9 per cent for all banks. Of this, the requirement for Tier I, which consists mainly of share capital and disclosed reserves and is deemed to be of the highest quality, is 6 per cent, or two-thirds. The capital requirement will go up by at least 200 percentage points under Basel III.
As the government clearly can't meet all their requirements due to fiscal constraints, PSBs have been asked to look elsewhere for more money. However, volatile stock markets and current low valuations may make this exercise difficult. The government had given in-principle approval to nine banks in 2013-14 for raising capital from the market as and when needed. These included Indian Overseas Bank (Rs 748 crore), Syndicate Bank (Rs 200 crore), and State Bank of India (Rs 11,500 crore). However, only SBI raised Rs 8,031 crore through qualified institutional placement, resulting in reduction of government holding to 58.6 per cent. Its target was to raise Rs 9,600 crore but many foreign institutional investors gave the issue a miss.
In the full Budget in July, PSBs may get about Rs 19,000 crore. For the rest, the banking department has asked them to look at innovative ways such as raising money from employees by giving them stock options, perpetual bonds, tapping equity markets or setting up a bank-wise holding company: the bank will transfer all its subsidiaries to the new company which in turn can tap the market for funds. Another option for recapitalisation is that a bank could set up a special purpose vehicle (SPV) to which it would transfer its real estate assets at market rate. The bank then could pay rental or lease to the SPV to create an income stream for it. Based on this income stream, the SPV would raise money from the market. "We have been telling banks that they should come out with out-of-box solutions," Financial Services Secretary GS Sandhu had said after a meeting with bank chiefs earlier this month.
It is also being discussed to what extent the government should bring down its stake in PSBs, which will help them raise money from private investors. The previous government was not ready to reduce it below 51 per cent, but a recent report by the committee headed by PJ Nayak, former chairman of Axis Bank, suggested the government should cut its holding in PSBs to below 50 per cent. "The government has two options: either to privatise these banks and allow their future solvency to be subject to market competition, including through mergers, or to design a radically new governance structure which would better ensure their ability to compete successfully, in order that repeated claims for capital support from government, unconnected with market returns, are avoided," the panel noted.
Experts say the issue is not the availability of capital from private sources, but the price at which the poorly performing banks can raise this capital or debt, given some really serious concerns around governance, human capital and the viability of their business model in a more competitive landscape. "The better run banks will find it easier to take advantage of any of these measures. Unlike their majority shareholder (the government), the market will put its money on performance," says PricewaterhouseCoopers Executive Director Shinjini Kumar. The point that PSBs would be able to raise money more easily from the market by distancing themselves from the government's influence has also been made by RBI Governor Raghuram Rajan. "Indeed, the better performers will be able to raise more, unlike the current situation where the not so good performers have a greater call on the public purse," he pointed out at a recent event.
BREAKING THE BAD-LOAN TRAP
Ten years ago, when China's state-owned banks found themselves sitting on a mountain of bad loans, the country's central bank injected $45 billion from its foreign exchange reserves into two of its big lenders. But that option would not work for Indian banks as the capital is provided from budgetary resources. If the government injects more capital in PSBs, it would further widen the fiscal deficit and will force it to borrow from the market.
This in turn, could harden interest rates and stifle economic growth. The silver lining is that bad loans have moderated a bit and with the economy projected to grow at 6 per cent this year, against 4.9 per cent last year, more improvement can be expected. Gross NPAs of PSBs improved to 4.44 per cent of their total advances at end-March 2014, against 5.07 per cent at the end of December 2013. However, according to RBI Governor Raghuram Rajan, "it is too early to say we are at the end of the bad loan problem".
