Do public sector banks deserve a taxpayer bailout?

Fostering Public Leadership - World Economic Forum - India Economic Summit 2010
The finance minister
Arun Jaitley said on June 12: “Banks have made a strong case for additional capital… And over the next few months, this is something the government is going to seriously look at.” Jaitley was talking about the government owned public sector banks.
There are two questions that crop up here: a) do public sector banks deserve additional capital? b) can the government afford it? Let me first define the word capital and then answer the second question first.
As Anat Admati and Martin Hellwig write in
The Bankers’ New Clothes: “In the language of banking regulation, this word [i.e. capital] refers to the money that the bank has received from its shareholders or owners. This is to be distinguished from the money it has borrowed. Banks use both borrowed and unborrowed money to make their loans and other investments. Unborrowed money is the money that a bank has obtained from its owners if it is a private bank or from its shareholders if it is a corporation, along with any profits it has retained.”
In case of public sector banks, the government is the biggest shareholder and any capital infusion would mean the government investing more money in these banks. How much money does the government need to infuse in these banks? In a research note titled
A Growing Need for Indian TARP, Anil Agarwal, Sumeet Kariwala and Subramanian Iyer, analysts at Morgan Stanley estimate that an immediate infusion of around $15 billion (or Rs 96,000 crore assuming $1 = Rs 64) is needed in these banks. And that is clearly a lot of money for the government to spend in a single year. The budget for 2015-2016 provided Rs 11,200 crore towards fresh capital infusion by the government in public sector banks.
The PJ Nayak committee report released in May 2014, estimated that between January 2014 and March 2018 “public sector banks would need Rs. 5.87 lakh crores of tier-I capital.” The report further points out that “assuming that the Government puts in 60 per cent (though it will be challenging to raise the remaining 40 per cent from the capital markets), the Government would need to invest over Rs. 3.50 lakh crores.”
It is safe to say that the government clearly does not have the kind of money that is needed to be invested in public sector banks. Now let’s try and answer the first question which is, whether the public sector banks deserve this kind of money to be invested in them by the government.
On the face of it, the answer is yes, simply because that public sector banks carry out nearly 70% of lending in India. And if they are not adequately capitalized, they will not be able to lend as freely as they may want to and as may be needed.
But there is more to it than just that. As the Morgan Stanley analysts point out: “
The current managements’ policy of “extend and pretend” is causing banks to move further into problems.” What do they mean by extend and pretend? Crisil Research estimates that 40% of the loans restructured during 2011-2014 have become bad loans.
A restructured loan is where the borrower has been allowed easier terms to repay the loan (which also entails some loss for the bank) by increasing the tenure of the loan or lowering the interest rate. If 40% of restructured loans have gone bad, it is safe to say that the banks have been essentially restructuring loans in order to postpone recognizing them as bad loans, which is what the Morgan Stanley analysts meant by “extend and pretend”.
Interestingly, bad loans are expected to go up during this course of the year primarily because more and more restructured loans will turn into bad loans. The Morgan Stanley analysts expect nearly 65% of restructured loans to turn into bad loans.
Further, as
Crisil Research points out in a research note titled Modified Expectations: “Reported gross non performing assets[bad loans] will still remain at elevated levels as some of the assets restructured in the previous 2-3 years, especially in the infrastructure, construction, and textiles sectors, degenerate into non-performing assets again.”
Also, as Debashis Basu
points out in a column in the Business Standard, that other than an increase in bad loans, “the continued evergreening of bad accounts – and, what is worse, the continued dubious new lending by public sector banks, with minimal collateral, arranged by touts,” continues to remain a worry.
In this scenario there is no point in the government putting in more hard-earned money of taxpayers into these banks. Until, Jaitley’s statement on June 12, the government’s stand was that additional capital would be put into public sector banks only after they improve the governance structure of public sector banks. The irony is that some of the biggest public sector banks have not had a CEO for many months now.
It had also asked the banks to reduce government stake to up to 52% and raise money directly from the stock market. But given the weak balance sheets of many of these banks, this option really does not exist.
To conclude, it is worth asking, why does the government of India need to own 26 public sector banks, especially in a scenario where many of these banks will require a lot of money to be invested in the next few years?
The best bet for the government is to go in for “strategic disinvestment” of most of these banks. Given their distribution network they may be good bets for the private sector. Further, the government can continue to own the State Bank of India and probably four other best public sector banks, in order to ensure that it is able to push through its financial inclusion programmes.

The column originally appeared on The Daily Reckoning on June 16, 2015

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About vivekkaul
Vivek Kaul is a writer who has worked at senior positions with the Daily News and Analysis(DNA) and The Economic Times, in the past. He is the author of the Easy Money trilogy. Easy Money: The Greatest Ponzi Scheme Ever and How It Is Set to Destroy the Global Financial System , the latest book in the trilogy has just been published. The first two books in the trilogy were published in November 2013 and July 2014 respectively. Both the books were bestsellers on Amazon.com and Amazon.in. Currently he works as an economic commentator and writes regular columns for www.firstpost.com. He is also the India editor of The Daily Reckoning newsletter published by www.equitymaster.com. His writing has appeared across various other publications in India. These include The Times of India, Business Standard,Business Today, Business World, The Hindu, The Hindu Business Line, Indian Management, The Asian Age, Deccan Chronicle, Forbes India, Mutual Fund Insight, The Free Press Journal, Quartz.com, DailyO.in, Business World, Huffington Post and Wealth Insight. In the past he has also been a regular columnist for www.rediff.com. He has lectured at IIM Bangalore, IIM Indore, TA PAI Institute of Management and the Alliance University (Bangalore). He has also taught a course titled Indian Economy to the PGPMX batch of IIM Indore. His areas of interest are the intersection between politics and economics, the international financial crisis, personal finance, marketing and branding, and anything to do with cinema and music. He can be reached at vivek.kaul@gmail.com

2 Responses to Do public sector banks deserve a taxpayer bailout?

  1. subra1221 says:

    The question to ask is why does the government need 26 banks, 4 life insurance companies (LiC, SBI, Canara Hsbc, …) a few mutual funds (Uti, Sbi, Canara, …). Cant they merge all of these and reduce head count?

    • vivekkaul says:

      I am not a great fan of merging organisations. What will happen is that the bad banks will me merged with the slightly good ones and pull down performance. Best is to let them go.

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