The government recently announced capital infusion of Rs 70,000 crore in public sector banks over the next four years. The banks are grappling with bad loans, thanks to the economic slowdown, which has seriously eroded their capital base. The question is, will this money be enough to restore the financial health of the banks?
In 2012, the Reserve Bank of India had estimated that public sector banks required equity support of Rs 175,000 crore. In last year's budget, Finance Minister Arun Jaitley had said the money required for the purpose would have to be as much as Rs 240,000 crore. From that point of view, the money may not be enough.
However, the money is certainly an improvement over earlier infusions. The government had initially allocated a mere Rs 11,200 crore for this financial year. Banks, naturally, raised a hue and cry about it. Then, following RBI's intervention, the government has decided to more than double it to Rs 25,000 crore.
A similar amount will be provided next year. After that, the infusion will fall to Rs 10,000 crore for two years. The rise in the share prices of public sector banks after the announcement shows that the market has taken positively to the infusion.
But it cannot be denied that public sector banks cannot rely on capital infusion from the government alone: they need to tap the equity markets sooner than later. According to one estimate, these banks need to raise Rs 110,000 crore from the market to support growth.
Global Rating agency Moody's says Indian government's plan is credit positive, as it has reversed an earlier policy of selective capital infusion; still, the amount is small and banks will need to raise additional capital from the equity markets.
However, there is not much appetite for public-sector bank paper among investors. And this is evident from the fact that barring three large ones- State Bank of India, Central Bank and Bank of Baroda - all others are trading far below their book value. The prices of the three at the bottom - Indian Overseas Bank, Dena Bank and Punjab & Sind Bank - are 35 per cent of their book value.
"Apart from a few banks like SBI, there is hardly any demand from investors. If banks have to come to the market, from the fourth ranked to the twentieth will hardly find any demand," says Nomura Financial Advisory and Securities (India) Vice-president Adarsh Parasrampuria who tracks the banking sector.
One reason for such a state of affairs is that the internal capital generation through retained earnings of public sector banks has declined steadily over the last three financial years: from over Rs 36,000 crore in 2012-13 to about Rs 28,000 crore in 2014-15, according to BS Research Bureau.
The capital base of public sector banks has seen erosion because of the higher provisioning for bad loans and restructured advances. They have a dominant share in infrastructure projects, many of which are mired in delays and regulatory clearances.
The other option of capital before the banks is to raise additional Tier-I capital, but the present investor pool for these instruments is limited. And, in the absence of a vibrant corporate bond market, banks will have to fall back on the equity market for meeting their capital requirements.
Banks raised capital worth Rs 15,000 crore in 2014-15 through Tier-I instruments at higher coupon rates. Investors sought higher rates to factor risks of investing in paper issued by entities with stressed balance sheets. Later, many banks had to call off plans to issue Tier-I paper due to the lack of investor appetite.
What has complicated matters is that the government is believed to have asked banks to issue bonds at lower interest rates. Rating agency ICRA has pegged such issuances in 2015-16 at Rs 30,000-35,000 crore.
There are other problems too. An arranger of perpetual bonds who does not wish to be named says: "Earlier, provident funds used to buy these bonds. But now they may not invest because these bonds are at times rated below AA; as a result, provident funds cannot invest in these bonds."
According to him, as provident funds can park only 2 per cent of their investments in perpetual bonds, it will not be easy for banks to market these bonds.
Apart from the high incidence of bad loans, governance is another issue that hurts public sector banks, which is impacting valuations. It is more than a year that Bank of Baroda, the second largest lender in the country after SBI, has not had a full-time chief executive. Same is the case with other large lenders like Canara Bank, Punjab National Bank, Bank of India and IDBI Bank.
ICRA Co-head (financial sector ratings) Vibha Batra says public-sector banks need to improve efficiency and also present themselves better if they desire higher valuations.
The government has shown its intention to reform public sector banks, in line with the PJ Nayak Committee's recommendations. But the pace has been slow. Industry experts are not optimistic of major changes in the next two years.
"The government is addressing structural issues like governance and recoveries from bad loans. But this is going to take time. Till that happens, it will have to infuse more capital than the estimated Rs 70,000 crore," India Ratings Managing Director & Chief Analytical Officer Ananda Bhaumik says.
Nomura agrees that the next two years will be challenging. "Hopefully, after two years, things will improve after which valuations may become better. The government may have to provide more funds if things do not improve," Parasarampuria says.