Free the banks

Last Friday, at a meeting with public sector bankers, Finance Minister P Chidambaram made it clear that the government's holding in the public sector banks cannot be diluted below 51 per cent.

The implications are clear. Unless these banks post handsome profits and raise their net worth, their capital adequacy ratios (CAR) will drop below the stipulated minimum and they will then be unable to build new assets.

At least two of the nationalised banks""Dena Bank and Oriental Bank of Commerce""have already brought down the government stake to almost 51 per cent.

This means that these banks will not be allowed to enter the capital market any more unless the government decides to bring down its stake to below 51 per cent, or contributes with fresh equity.

Both options are ruled out, the latter because of fiscal constraints. Another four banks""Vijaya Bank, Allahabad Bank, Punjab National Bank, and Corporation Bank""have very little leeway to raise fresh money from the market as the government stake in these banks varies between 53.87 per cent and 57.17 per cent.

These six banks are in a fix as they need to shore up their CAR in order to be able to continue to grow.

In fiscal 2005, the banking system's non-food credit growth was 26.5 per cent, or Rs 2,13,464 crore""the second highest growth in 55 years.

Since banks' CAR is now pegged at 9 per cent, this credit growth has eaten up over Rs 19,000 crore worth of capital. If this momentum continues, some of the banks will find it hard to meet their CAR requirements.

For instance, Oriental Bank of Commerce's CAR has already come down to 9.21 per cent. And the new Basel norms, which come into effect in 2007, will dent their CAR further.

Though the CEOs of some listed banks have hinted that they will approach the government for fresh capital, this is not likely to help as there is a fiscal constraint.

The Centre has pumped over Rs 20,000 crore into the public sector banking industry over the last decade to shore up the capital base of its banks, but this was done only for unlisted banks.

The only way left for these banks to raise their CAR is to float long-term Tier II bonds, but this is capped at 50 per cent of Tier I capital. The listed banks can float rights issues, where the government can put in fresh capital, but the current market price will act as a constraint.

The logical solution is to bring down the government stake below 51 per cent and allow these banks to enter the capital market. Yashwant Sinha thought he had found a solution by proposing as finance minister that the banks could retain their public sector character even if the government stake dropped to 33 per cent.

But this is unlikely to pass muster with the Left. The end result is that the public sector banks will soon face limits to growth, which will be a perverse result of the Left's dislike of market capital.