For some time now, analysis of quarterly results of banks has been dominated by growing concerns about asset quality. The increasing scale of this problem comes at a time when the entire banking system is being asked to comply with Basel III norms, which, with reference to capital adequacy, emphasise the importance of equity capital. If the banking system is to expand credit at 20 per cent or so per year over the next five years, even if it meets the adequacy standards today, which most banks in the public sector do, it will have to grow its equity capital at the same rate to maintain adequacy. The greater the share of profits being garnered by provisioning against bad assets, the less internal capital there is available to grow equity. Consequently, growth must be supported by infusion of external funds. In public sector banks, which carry a disproportionate share of the bad assets, the government has to either dilute its stake substantially or find resources within the budget to enhance capital without ceding control.
Some estimates suggest that at the current level of non-performing assets, around 10 per cent of the banking sector's advances, and taking into consideration the prospect of some of the "restructured" loans also turning bad, banking capital needs to be enhanced by more than Rs 1 lakh crore a year over the compliance time frame. Much of this, of course, will have to go into the public sector banks. Even allowing for some range to these estimates, the provision made in the interim Budget for bank re-capitalisation of Rs 11,200 crore falls far short of even the minimum requirement. With such a shortfall in this year, the pressure to catch up will become more and more intense as the deadline approaches. Future Budgets will find themselves increasingly constrained in terms of their ability to finance welfare and investment programmes as the demands made by the banking system for capital escalate. Clearly, this is an untenable situation; even if economic growth recovers, easing some of the pressures emanating from the business cycle, the burden is too heavy to correct itself. A strategic response is called for.
Three components need to be brought together to address the problem. First, the government must push hard for consolidation of smaller public sector banks, creating more sectorally and regionally diversified institutions, with consequently less risks. Union resistance to this must be firmly pushed back. The large-scale retirements from banks over the next few years offer an opportunity to consolidate and streamline operations, which must be exploited. Second, government stakes in all banks must be brought down to the minimum needed to retain control in those banks in which it is deemed necessary (which may be none or very few). For others, private banks - existing and prospective - should be allowed to acquire them, giving them the opportunity to combine new technologies and strategies with established branch networks. Employees can be protected, at least with respect to wages and pensions, in the sale contract. Third, bankruptcy, repossession and disposal processes must be very quickly ramped up, helping banks clean up their books and acting as a credible threat to defaulting borrowers. The more this process is delayed, the greater the damage that can be caused.
