PSBs' Recapitalization: The Global ANALYST, December 2017

This is the 3333rd post on this blog. My thanks to all those who have made this possible.
MG Warrier

The Global NALYST, December 2007

PSBs’ Recapitalization*
Last Hurrah!
M G Warrier
Union finance minister Arun Jaitley by announcing the comprehensive recapitalization plan for public sector banks has done a commendable service to the banking system. The sagging image of Indian Banking System which had shouldered the major burden of the cleansing process of Indian Economy initiated by RBI and GOI last year has got a deserving boost by this timely measure. The Finance Minister gave the following details about  the recapitalization plan for state-run banks worth Rs 2.11 lakh crore approved by the Union Cabinet:
·       Of Rs2.11 lakh crore, a sum of Rs 1.35 lakh crore will be raised through recapitalization bonds while another Rs 76,000 crore would be available from budgetary support and raised through market borrowings.
·       The exact nature of these recapitalization bonds will be released later and the capital infusion plan may run into the next fiscal year.
Jaitley, during the press briefing about the recapitalization plan attributed the recent visible rise in NPAs to their being swept under the carpet till 2015, from when transparency came and indiscriminate lending by state-run banks between 2008 and 2013. He added that the banks now have adequate lending capacity post demonetization.
Mainstream media has never been kind to Public Sector in general and Public Sector Banks in particular. A business magazine concluded its editorial last month (November 6-9, 2017 issue) with these words:
“We at……have long been skeptical of any real change, without real privatization. People (and even the BJP) forget that the BJP opposed Mrs Gandhi’s nationalization of the banks. And one only has to compare the value creation in the last two decades by private sector banks, compared with the huge value destruction in the public sector. We have also repeatedly pointed out that banking is an industry which is over 200 years old in India, and where we have a natural advantage.
It is this opportunity that a newly energized finance minister must sieze.”
Good enough cocktail of facts, fiction and history to confuse a NewGen reader. Before moving forward, we will have a look at the major claim about ‘value addition’. This value addition has happened only for the capital invested by ‘private’ owners of the private sector banks. Even the institutions have not benefited. Look at the growth in the business share or benefits passed on to borrowers in terms of interest rates reduction by bringing down net interest margins(NIM) by big private sector banks.
The argument against poor management of Public Sector Banks(PSBs) by their owner, namely GOI is not without basis. PSBs with the exception of SBI and its Associates (now merged into SBI) came into being through nationalization of private sector banks. Post-Nationalization, as the prime objective of nationalization was to make banks deploy the resources mobilized from public for the benefit of the public, in effect, management of PSBs were handed over to bureaucrats who were accountable only to the political leadership which controlled government. Professionalism was conspicuous   by its absence from bank board rooms down to appraisal of loan proposals. Political parties in power both in Delhi and in states started using banks for implementing populist projects and forced waiver of loans when they became bad. The need of the hour is de-politicisation of banking business and infusing professionalism in the working of banks. The solution lies in providing a level playing field for PSBs and their private sector counterparts in management and business decisions within the contours of national policy in regard to prioritization of credit flow and ensuring geographical spread of bank branches. There is no escape from banking sector reforms.
Unlike other institutions, even the public sector – private sector divide does not make much sense in the case of banking business. Leaving the relatively small capital, for major portion of the resources both categories of banks depend on deposits from public/government. Considering the nature of service they provide as part of business, namely lending to earn returns and managing funds mobilized keeping the depositors’ interest in view, banks in private and public sectors have to work with equal professionalism.
RBI welcomes
Reserve Bank of India Governor Urjit Patel has welcomed the bank recapitalization plan announced by GOI. In the statement issued soon after announcement of Recapitalization Plan by the Finance Minister, Governor said in a statement (See Box) that “A well-capitalized banking, and in general, financial intermediation, system is a pre-requisite for stable economic growth. Economic history has shown us repeatedly that it is only healthy banks that lend to healthy firms and borrowers, creating a virtuous cycle of investment and job creation.” Adding that, “For the first time in last decade, we now have a real chance that all the policy pieces of the jigsaw puzzle will be in place for a comprehensive and coherent, rather than piece-meal, strategy to address the banking sector challenges.”

Statement issued by RBI welcoming bank recapitalization plan

RBI welcomes bank recapitalization plan. A well-capitalized banking, and in general, financial intermediation, system is a pre-requisite for stable economic growth. Economic history has shown us repeatedly that it is only healthy banks that lend to healthy firms and borrowers, creating a virtuous cycle of investment and job creation. The Government of India’s decisive package to restore the health of the Indian banking system is in the view of the Reserve Bank of India (RBI), a monumental step forward in safeguarding the country’s economic future. For the first time in last decade, we now have a real chance that all the policy pieces of the jigsaw puzzle will be in place for a comprehensive and coherent, rather than piece-meal, strategy to address the banking sector challenges. It bodes us well that this step has been taken in a time of sound macroeconomic conditions for the economy on other fronts. The proposed recapitalization package for the banking sector combines several desirable features. First, by deploying recapitalization bonds, it will front-load capital injections while staggering the attendant fiscal implications over a period of time. As such, the recapitalization bonds will be liquidity neutral for the government except for the interest expense that will contribute to the annual fiscal deficit numbers. Second, it will involve participation of private shareholders of public sector banks by requiring that parts of the capital needs be met by market funding. Last but not the least, it will allow for a calibrated approach whereby banks that have better addressed their balance-sheet issues and are in a position to use fresh capital injection for immediate credit creation can be given priority while others shape up to be in a similar position. This provides for a good way of bringing some market discipline into a public recapitalization program compared to the past recapitalization programs. Financial sector policies should support growth while maintaining financial stability. On behalf of the Reserve Bank of India, I commend the government on its bold steps in this direction, starting with implementation of the Insolvency and Bankruptcy Code that is helping resolve the underlying corporate stress, and culminating in yesterday’s announcement of the public sector bank recapitalization program. The RBI looks forward to working with the Government to ensuring these plans reach their natural completion to the benefit of the broader Indian economy.

(Urjit R. Patel)
 Governor

CAG’s perception
A recent Performance Audit Report covering the working of Public Sector Banks released by the Comptroller and Auditor General, inter alia, made the following observations:
·       Public Sector Banks (PSBs) account for over 70 per cent of the deposits received in and advances made by Scheduled Commercial Bank (SCBs). The capital requirement of PSBs is driven by credit growth in the economy and prudential regulatory requirements. The regulatory framework for banks is globally framed by the Basel Committee on Banking Supervision which is adopted by RBI for Indian banks. Over 2008-16, the advances of PSBs have more than doubled, from Rs22,59,212 crore to Rs55,93,577 crore, though the rate of increase in advances had decreased from 19.56 per cent in 2009-10 to 2.14 per cent in 2015-16.
·       The return on assets (ROA) of PSBs which is a measure of their profitability has been consistently lower than that of SCBs (2011-16). PSBs account for nearly 88 per cent of Gross Non-Performing Assets (GNPAs) of the banking sector in 2015-16. There is a significant gap between book value and market value of PSB shares, with most PSBs having a lower market value which may come in the way of PSBs approaching the market for additional capital funds. II Infusion of Capital Funds by GOI in PSBs GOI infused Rs 1,18,724 crore in PSBs during 2008-09 to 2016-17.
·       The basis for working out parameters for capital infusion changed between actual and estimated values from year to year and often within different tranches in the same year (2010-11, 2015-16 and 2016-17). For FY 2014-15, there was a shift from ‘need based’ to ‘performance based’ capital infusion, with ROA being employed as the basic criteria for capital infusion.
·        As per Indradhanush plan, for FY 2015-16, 20 per cent of the earmarked capital infusion was to be allocated to PSBs based on their performance during three quarters in FY 2015-16, which was not adhered to on account of the Asset Quality Review by RBI.
·       In FY 2011-12, SBI was the only PSB which was infused with Rs7,900 crore, over and above the regulatory requirement being ` 5,874 crore, on grounds that with impending norms of Basel III, SBI would be required to maintain a 11 per cent Tier I CRAR target. The 11 per cent norm for SBI was not followed in future years. During 2013-14, four PSBs which had a GOI shareholding above 58 per cent and did not require capital to meet the Tier I CRAR target, were infused with capital to the tune of Rs 2,900 crore. This was done even as the requirement of 11 PSBs to meet the Tier I CRAR target, was not fully met. Against a target under Indradhanush for raising capital from the market by PSBs to the tune of Rs 1,10,000 crore between 2015-16 and 2018-19, during January 2015 – March 2017, only Rs 7,726 crore could be raised.
Bleeding wounds
Though no one would like to question the noble intentions behind several initiatives taken by Dr Raghuram G Rajan during his relatively short stay in India as RBI Governor, fact remains that several corrective and transplantation surgeries he initiated have left the Indian Financial Sector bleeding with several open wounds. As he would later claim, he did what he did, with conviction. Rajan had done his homework much before he took charge as RBI Governor and he could start working in full swing right away on September 4, 2013 and he maintained the tempo right up to the first week of September 2016 when he left for Chicago. He had a pragmatic approach to revamping the institutional structure in the financial sector, giving new content and meaning to Monetary Policy and most importantly handling the NPA menace which had gripped Indian banks. There are no comforting indications from Mint Road now to feel convinced that all the good initiatives taken during the ‘Rajan Era’ are being pursued with vigour towards their original objectives.
Made these observations in the context that the proposed Bank-Recapitalization  is like a transplantation surgery. The difference here is the organ (funds for recapitalization) for transplantation is being removed from the same body (Indian Economy) into which it is being transplanted. In such a situation maintaining the health of Indian Economy and the Banking System which forms part of it becomes more significant. Simply put, structural reforms of banks, infusion of professionalism into the working of banks or banking reforms in general, have gained urgency at this stage.

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*Submitted version

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