Story Of The Week

The Big Bang “Re-capitalization of Banks”

Introduction

Today’s story starts with loads of Bad Debts! In the past few years, various loans were given by Indian banks. Unfortunately, many of these loans were never paid back. The defaulters, some of them owed over  500 cr decided to live a lavish lifestyle, and didn’t repay anything.

When Reserve Bank of India started conducting an Asset Quality Review,  Indian Public Sector Banks(PSBs) had to unveil their Non Performing Assets (NPAs).

Asset Quality Review: In August- November period in 2015, a special inspection was conducted. This was different from the typical Annual Financial Inspection process. The Asset Quality Review inspected most of the large borrower account and checked if they agreed to the rules. Banks were asked to declare 200 of these accounts as non-performing.

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The troubles became apparent as losses mounted. The State run banks wrote off  81683 cr bad loans in the FY ended March 17, as compared to the Previous Year’s 57586 cr. Further, the August 17 report by Care Ratings clearly mentioned that in FY18, NPAs of a sample of 38 banks increased by 34.2% y-o-y. The report went on to state the q-o-q increase in NPVs was about 16.6% in Q1- FY18. The combined data showed a 135% increase in the last two years.

Out of total NPA, SBI accounted for the largest share of about 22.7%. Top five banks (SBI, PNB, BOI, IDBI and BOB) accounted for around 47% NPA. There were only two stressed private sector banks in the top 15 : ICICI Bank and Axis Bank. Thus, it became clear that Public sector banks had taken a bad hit.

In the past few years, several measures have been taken by the government to tackle NPAs including the amendment in recovery laws, merging associate banks with SBI and enacting the Insolvency and Bankruptcy code (encouraging banks to proceed against defaulters). Today, we discuss another recent approach for the same: Recapitalization.

If you keep abreast with the news, you may have guessed the reason for us bringing up this topic today. Last Tuesday, the Government of India approved an unprecedented, whopping amount of Rs.2,11,000 crore($32 billion) package to revitalize Public Sector Banks.

How’s this “Re-capitalization” going to happen?

On 24 Oct 2017, the government announced its plan to inject 2.11 trillion rupees into struggling state-run banks over the next two years. Of this, 1.35 trillion rupees, i.e, about two-thirds, will be raised from recapitalization bonds. The rest ₹760 billion will come from budgetary support and the market borrowings.

Recapitalisation bonds (Recap Bonds) are instruments issued by the government that banks can buy, so that the government will, in turn, use the money therefore raised to provide more capital to the banks. This would not just allow banks to lend more, but will also help by having them comply with adequacy norms Basel III.

Though the government has not revealed the nature of the bonds and the issuing authority, it has said most of it will be front-loaded(distributed or allocated unevenly, with the greater proportion at the beginning of the process).

This front-loading of capital will help PSBs because infusing capital in the beginning of the financial year will help banks plan their lending and provisioning for NPAs for rest of the year.

Coming to budgetary support, banks are expected to get Rs. 18,000 crore under the Indradhanush mission. (Indradhanush programme is a government initiative started in 2015, to revamp functioning of public sector banks. Under this mission, govt had announced to infuse Rs. 70,000 crore in state-run banks over four years to meet their capital requirement in line with global risk norms.)

Talking about Market borrowings, this recapitalization will build confidence in investors to invest in public sector banks which were saddled with NPAs. So banks can go for market borrowings to raise about Rs 580 billion. As government willing to accept a dilution of its ownership share to 52% in PSUs, one of them could be government’s equity dilution.

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Spur to Private Investment

From the last few years, with a mountain of bad debts, the ability of banks to extend new credit has compressed. With increasing NPA provisions for bad loans, the earnings of many public sector banks have eroded over the last one to two years. Because of it, the stock prices of these PSBs are clearly marked down on the stock market.

Recapitalization instantly put public bank stock prices on a surge.

*As we know, when a company’s stock price increases, so does its market value which in turn helps the company to comfortably raise money. This is much required for PSBs to spur private investment.

Response to this Development

Positives:

According to CRISIL, PSBs need additional Rs 1.4 to 1.7 lakh crore to comply with Basel III requirements by March 31, 2019. So, CRISIL believes Government’s 2.11 lakh crore recapitalisation package is a credit positive and a major step in revitalising PSBs.

Major Global Rating firms like Moody’s and Fitch Ratings perceive this step to be credit positive as this addresses the weak core capitalization.

Negatives:

Goldman Sachs says bank recapitalisation could lead to RBI hiking rates. As factors like improvement in growth expectations and upside risks to the fiscal deficit may lead to that decision in long-term. Some analysts believe that without a reform, this package is just another bailout. They also said that as Indian PSBs are constant subject to political pressure, these banks often need a bailout.

In a press meet, a top leader of All India Bank Employees Association(AIBEA) said: though recapitalisation would give a pump to the banks it is only a short-term relief as banks are facing a major problem of mounting bad debts and restructured loans making the total NPA to 15 Lakhs. This has compelled the banks to make provisions from profits thus decreasing the capability of banks to internally raise capital, hence impacting the capital adequacy ratio. Thus, inducing capital is a short-term solution but recovery of loans is a long-term process.

This mixed response when still deets, like the structure of the recap bonds and the amount of capital that individual banks will receive, are yet to be disclosed.

Chief Economic Advisor Arvind Subramanian has tweeted that the true cost for a government of issuing the 1.35 lakh crores recap bonds is the annual interest payment, about Rs. 8000-9000 crores. He believes that this cost can be balanced out by confidence impact of addressing critical bottleneck, increasing credit, private investment, and growth.

These recap bonds come under “below-the-line” financing. Though under IMF accounting, it doesn’t add to fiscal deficit but, under Indian accounting, it does add. To conclude, the extent to which this recapitalisation would affect fiscal deficit is to be seen.

References

http://www.thehindu.com/business/Industry/Asset-Quality-Review-and-its-impact-on-banks/article14494282.ece

https://blogs.economictimes.indiatimes.com/FindingtheCenter/bank-recapitalization-an-integrated-package/

https://www.bloomberg.com/view/articles/2017-10-26/india-s-banks-need-more-than-a-bailout

http://www.livemint.com/Opinion/Bvs4qz9YIJ6FjtJeklw8PI/A-lease-of-life-called-bank-recapitalization.html

https://scroll.in/article/855660/capital-infusion-for-indias-banks-must-be-accompanied-by-reforms-or-it-will-be-in-vain-say-experts

http://in.reuters.com/article/india-economy-banks-copy/india-embarks-on-32-4-billion-state-bank-recapitalisation-to-boost-economy-idINKBN1CU07G

https://economictimes.indiatimes.com/industry/banking/finance/banking/government-infusing-capital-in-banks-only-short-term-solution-aibea/articleshow/61273305.cms

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