With Rs 70,000 cr bailout of banks, Modi’s minimum govt vision has gone for a toss

narendra_modi
The government of India has planned to put in Rs 70,000 crore into public sector banks over the next four years. “As of now, the PSBs are adequately capitalised and meeting all the Basel III and RBI norms. However, the government wants to adequately capitalise all the banks to keep a safe buffer over and above the minimum norms of Basel III. We have estimated how much capital will be required this year and in the next three years till financial year 2019,” a ministry of finance press release pointed out.

The press release further pointed that: “If we exclude the internal profit generation which is going to be available to PSBs (based on the estimate of average profit of the last three years), the capital requirement of extra capital for the next four years up to FY 2019 is likely to be about Rs.1,80,000 crore.  This estimate is based on credit growth rate of 12% for the current year and 12 to 15% for the next three years depending on the size of the bank and their growth ability.”
This theme of rescuing public sector banks is something I have discussed in the past. And honestly, I am disappointed with the government deciding to spend to so much money over them. There are number of reasons for the same.

The latest release by the ministry of finance suggests that public sector banks are going to need Rs 1,80,000 crore of extra capital over the next four years. Of this amount the government plans to plough in Rs 70,000 crore.

(i) Financial Year 2015 -16 Rs. 25,000 crore

 

(ii) Financial Year 2016-17 Rs. 25,000 crore

 

(iii) Financial Year 2017-18 Rs. 10,000 crore

 

(iv) Financial Year 2018-19 Rs. 10,000 crore

 

  Total   Rs. 70,000 crore

 

Source: Press Information Bureau

These numbers are very different from the numbers put out by the PJ Nayak committee report released in May 2014. The committee estimated that between January 2014 and March 2018 “public sector banks would need Rs. 5.87 lakh crores of tier-I capital.” The committee further said 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.”

The difference between the number put out of by the ministry of finance last week and the number put out by the PJ Nayak committee is huge. The PJ Nayak Committee said that the government would need to invest Rs 3,50,000 crore by March 2018. The government is investing only Rs 70,000 crore by March 2019. If the PJ Nayak Committee number is the amount of money that is required then the money being put in by the government is basically small change.
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. Either ways what the government plans to invest is too small in comparison to what may be required at this point of time.

Further, other than requiring a massive infusion of money, these banks continue to face a significant amount of bad loans. As the latest RBI Financial Stability Report released in June 2015 points out: “Five sub-sectors, namely, mining, iron & steel, textiles, infrastructure and aviation, which together constituted 24.8 per cent of the total advances of scheduled commercial banks, had a much larger share of 51.1 per cent in the total stressed advances. Among these five sectors, infrastructure and iron & steel had a significant contribution in total stressed advances accounting for nearly 40 per cent of the total. Among the bankgroups, public sector banks, which had the maximum exposure to these five sub-sectors, had the highest stressed advances.”

Around 30.5% of the stressed advances of public sector banks come from the infrastructure sector. Nearly 10.5% comes from iron and steel sector.
The stressed assets are arrived at by adding the gross non performing assets(or bad loans) plus restructured loans divided by the total assets held by the Indian banking system. The borrower has either stopped to repay this loan or the loan has been restructured, where the borrower has been allowed easier terms to repay the loan by increasing the tenure of the loan or lowering the interest rate.

The trouble is that many public sector banks have essentially been using the restructuring route to avoid recognising bad loans as bad loans.  The Morgan Stanley report referred to earlier points out: “The current managements’ policy of “extend and pretend” is causing banks to move further into problems.”
The banks have been kicking the can down the road by refusing to recognise bad loans upfront. In a research note published earlier this year, Crisil Research estimates that 40% of the loans restructured during 2011-2014 have become bad loans. Morgan Stanley estimates that 65% of restructured loans will turn bad in the time to come.

What this tells us actually is that any capital infusion will essentially not amount to much given that bad loans will keep piling up. In a research report titled Current Worries Crisil Ratings has estimated that “around 46,000 mw of power generation projects (36,000 mw coal-based and 10,000 mw gas-based) are in distress today. Loans to these projects are around Rs 2.1 lakh crore, with about two-thirds lent by public sector banks.”

Further, of these loans “as much as Rs 75,000 crore of loans – or nearly 15% of aggregated debt to power generation companies — are at risk of becoming delinquent in the medium term.”

So, along with putting money in public sector banks the government needs to come up with a plan on how to stop these banks from bleeding. Any capital infusion plan is incomplete without a plan on how to counter mounting bad loans. As S.S. Mundra, deputy governor of the Reserve Bank of India said in a recent speech: “The issue is how to deal with imprudent and non-co-operative borrowers, wilful defaulters or for that matter, fraudsters? It is important that the errant borrowers are quickly brought to book and recovery proceedings be completed as early as possible. A non-performing account of whatever origin and pedigree, is a drag on the banking system and increases the cost of intermediation, which pinches an honest borrower the most. It is important for the system to weed out the unethical elements at the earliest opportunity to ensure the credibility and the efficiency of the credit system in the country.”

Further, as I have pointed out in the past, why does the government need to own 25 public sector banks? There is clearly no point in continuing to own 25 banks, especially given that they require a massive amount of money to continue functioning.

The government plans to allocate Rs 25,000 crore to these banks during the course of this year. Of this around 40% (Rs 10,000 crore) the second tranche will be allocated to the top six banks (State Bank of India, Bank of Baroda, Bank of India, Punjab National Bank, Canara Bank and IDBI Bank). This will be done “in order to strengthen them to play a vital role in the economy,” the ministry of finance press release pointed out.

The question is why doesn’t the government concentrate on these six banks and sell off the remaining banks. Yes, it will be politically difficult. But why should the tax-payer keep bailing these banks out?

Further, as prime-minister Narendra Modi has said in the past: “I believe government has no business to do business. The focus should be on Minimum Government but Maximum Governance [the emphasis is mine].” This was his chance to implement this vision. But sadly that doesn’t seem to be happening.

The column was originally published on The Daily Reckoning on August 4, 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

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