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State-run banks face major obstacles in their plans to raise as much as $60 billion in new capital over the next few years, with investors sceptical about the prospects for most of them and workers wary of the government's grip loosening.
With the tailwind of a strong recent stock market performance on optimism about a new government led by Prime Minister Narendra Modi, the banks are preparing to raise capital to meet upcoming global regulations and to build a buffer against rising bad loans. Banks such as State Bank of India have appointed advisers for share sales.
But with their asset-quality deteriorating and credit demand slackening due to a sluggish economy and politically motivated lending, tapping the capital markets won't be easy for them.
Moreover, about a quarter of India's 26 state-owned lenders have a leadership vacuum. United Bank of India, which has the country's heaviest bad-loan burden, has had no chairman for nine months now.
"When you don't know what's going on, and why what's being done is done, you can't responsibly put your money," said Eric Mookherjee, a Paris-based fund manager at Shanti Asset Management, who has one state-run lender - Bank of Baroda - in his portfolio.
New Delhi's stakes in the state-run banks range from 56% to 84%. If these lenders, who account for 70% of India's total outstanding loans of about $1 trillion, are unable to raise the full capital sought or only some of it, the government will have to step in.
But the government may have a limited appetite to infuse such large funds directly. Investment bank Jefferies estimates that it has already pumped nearly $13 billion into state-run banks over the past decade. So instead, New Delhi might ask state financial institutions, such as Life Insurance Corp of India Ltd (LIC), to invest if the banks' capital raising is not successful.
Among state-run banks, only SBI, Bank of Baroda and Union Bank are well positioned to raise share capital on the strength of their balance sheets, said Manish Ostwal, banking analyst at brokerage K R Choksey.
SBI, India's biggest lender, is amongst the better-managed state-run banks but still had a return on assets ratio - a measure of profitability - of only 0.65. State-run Bank of Baroda had 0.75, compared with 1.73 for leading private sector lender ICICI Bank and 1.90 for HDFC Bank.
And profit per employee at SBI and its associate banks, with close to 300,000 staff, was Rs 6,00,000 for the year to March 2013, compared with Rs 14 lakh for ICICI.
Valuation of the shares could be another stumbling block. Of the 24 publicly traded state-owned banks, all but the two biggest have a price-to-book value of less than 1, meaning bigger dilution of existing shareholders.
Another challenge will be the powerful banking unions, which are reluctant to back plans that would cause the government's shareholding to fall, fearing job losses.
Vishwas Utagi, a bank union leader, said the Basel III global norms on capital requirements should not matter to state lenders: "The government nameplate is more than enough."
Instead, he said, the government should come up with stringent laws to recover bad and stressed loans - estimated at $97 billion. "Good money is being wasted for bad money."
The government has promised to reform the state-run banks, but it remains to be seen if the changes will come quickly and be effective. Some investors, though, say state-owned banks, if reformed, offer the best exposure to any sustained upswing in India's economy.
"They are always going to be the best proxy if anybody wants to play the Indian economy," said Nandkumar Surti, chief executive at JPMorgan's India asset management unit.
