Half a dozen weak public sector banks (PSBs) under the Reserve Bank of India's (RBI's) prompt corrective action (PCA) framework will soon be able to re-start lending. Union Budget 2019/20 has announced a Rs 70,000 crore capital infusion for state-owned banks, which control two-third of the banking system's deposits and advances. Also, strong non-banking financial companies (NBFCs) will now have a ready window to sell retail assets to banks to raise resources. The government has offered to protect the first set of losses (up to 10 per cent) that banks will suffer if these investments turn bad. Similarly, the government's bold decision to tap overseas markets for borrowings to bridge the fiscal deficit will ease pressure on banks to buy government securities. This will give banks more room to support India Inc. and lower long-term interest rates. This is, of course, risky too, as foreign currency volatility has the potential to increase the governments debt servicing burden drastically.
Finally, the task of regulating housing finance companies has been taken away from the National Housing Bank and given to the RBI. The RBI is in a much better position to regulate the segment and ensure financial stability, which was threatened after last year's IL&FS and Dewan Housing crises.
Given the liquidity and solvency issues, there was an urgent need to fix the many gaps in the financial system. The Budget tries to do just that. While many of the above mentioned measures will go a long way in strengthening the system, there is a need for improving governance, re-visiting many business models, encouraging new ones like payments and small finance banks and keeping a check on different market segments such as mutual fund, insurance, non-banks and banks due to their strong inter-connectedness.
Nuts & Bolts
The big surprise came for PSBs, which would get a whopping Rs 70,000 crore through issuance of recap bonds. These banks have been facing deterioration in asset quality, profitability and capital levels over the last four-five years. "The earlier capital infusion was largely used to address NPA issues of PSBs. This additional capital is likely to be used for asset growth," says Jaspal Bindra, Executive Chairman at Centrum Group. Care Ratings has estimated that if this additional capital is used for lending, it can increase bank credit up to Rs 6-6.5 lakh crore. In fact, credit offtake is already improving, especially from retail, MSME and agriculture sectors. Deposit growth, in single digits, has not been able to keep pace.
A stronger capital base for PSBs means they will be able to command better valuations in stock markets and raise additional money. "Many banks will be able to raise funds from stock markets at higher valuations once this capital comes in," says a private banker. Others suggest that more than the capital, the government should have focused on governance and structural issues. The Banks Board Bureau should have been empowered more, they say. Similarly, there is a need to set up a Bank Investment Company for housing government stake in PSBs and allowing it to raise resources independently. The merger of PSBs is another area where there is need for a better strategy. The government had recently initiated the merger of five associate banks of SBI and merger of Bank of Baroda, Vijaya Bank and Dena Bank.
The Budget has made some bold moves in insurance too. New insurance companies or those struggling for capital have got a boost. The Budget talks about raising the FDI limit from the existing 49 per cent in both life and non-life segments. While insurance arms of big players such as HDFC, Bajaj and ICICI may not need more capital, the mid-sized and smaller players will find this quite useful. In fact, the higher FDI limit will encourage many new foreign players to set up shop in India. The proposal to increase FDI in insurance intermediaries from 49 per cent to 100 per cent will help insurance brokers and aggregators, an important link for pushing insurance penetration.
"This measure will attract global insurance distribution companies to set up shop without worrying about finding a suitable Indian partner and ownership and control issues," says Amit Jain, President at Liberty General Insurance Company. At present, life insurance penetration in India is 3 per cent of GDP; general insurance trails at 1 per cent. However, domestic insurance broking firms are not enthused. Supriya Rathi, Promoter Director at Anand Rathi Insurance Brokers, says when the FDI limit was increased from 26 per cent to 49 per cent, only a couple of foreign players increased their stake in insurance broking. "They (foreigners) will not be focusing on micro insurance or smaller cities and towns. They will focus more on servicing the large clients," says Rathi.
However, one of the boldest decisions is diversifying government borrowings from purely domestic to foreign. This will lower the governments cost of funds and help banks by freeing them from the requirement of loading up on G-secs. This means they will be able to focus on lending for private investments. The government borrows in excess of Rs 6 lakh crore from the market in a year.
HDFC Bank, in an analysis of the Budget, said that once successfully established with global investors, a global bond instrument can play a critical role in reducing local borrowing pressure and crowding out impact of the government in the domestic market. Experts suggest the alternative would have been to increase the FPI limits in G-secs. "It seems the government did not have a choice given the receding retail interest in debt and limited FPI investments in local currency debt," says Sunil Sharma, CIO at Sanctum Wealth Management.
Easing NBFCs Pressure
The government has finally stepped in to ease pressure on NBFCs, which have been reeling under liquidity stress ever since IL&FS defaulted on repayment in September last year. Acknowledging the role of NBFCs in sustaining consumption demand and capital formation in SMEs, Finance Minister Nirmala Sitharaman said the government would provide a one-time six month partial credit guarantee to public sector banks to buy high-rated pooled assets worth Rs 1 lakh crore from NBFCs. "This will provide NBFCs the much-needed liquidity. They can thus liquidate their portfolio and meet their liabilities in a timely manner. Additionally, it will create an atmosphere of confidence," says Ramesh Nair, CEO and Country Head, JLL India.
Amit Goenka, MD and CEO at Nisus Finance, says this will accelerate monetisation of assets by NBFCs as banks will be able to acquire pooled loan assets without extraordinary caution on asset quality. "Many of these pooled assets include developer loans and home mortgages which will provide a huge liquidity fillip to NBFCs," he says.
The Budget also offers greater parity in tax treatment of NBFCs vis-a-vis scheduled banks. Under Section 43D of the Income Tax Act, banks were not required to pay tax on interest accrued in bad or doubtful debt until the interest payment is actually realised. The Budget has extended this facility to deposit taking as well as systemically important non-deposit taking NBFCs. "This will bring parity between scheduled banks and NBFCs. We now have a more level-playing field, a step forward towards harmonisation," says V.P. Nandakumar, MD & CEO of Manappuram Finance.
The Budget has also announced that the current requirement of creating a Debenture Redemption Reserve (DRR) will be done away with to allow NBFCs to raise funds in public issues. "The withdrawal of DRR requirements will allow higher allocation of capital and lower the cost of capital given by NBFCs to the real estate sector since a significant part of the financing occurs through NCDs (non-convertible debentures)," says Goenka. The Budget also seeks to permit investments by FIIs and FPIs in debt securities issued by Infrastructure Debt Fund - Non-Bank Finance Companies to be transferred or sold to any domestic investor within the specified lock-in period. "The new policies will foster a constructive climate for external investment in the country and ensure strong positioning of India in ease of doing business," says Rohit Poddar, Managing Director, Poddar Housing and Development.
While the current NBFC crisis was triggered after IL&FS defaulted on debt repayment in September last year, the reason behind the chain reaction was that the Indian corporate bond market is not deep enough. NBFCs run asset-liability mismatches as they borrow for six months and lend for 15-20 years as the Indian market is not mature enough to support issuance of 15-year bonds. So, the Budget has proposed that the government will work with the RBI and the SEBI to enable stock exchanges to allow 'AA' rated bonds as collaterals. This will deepen the corporate tri-party repo market. "These measures are expected to improve debt availability, especially for the infrastructure sector," says Rajeshwar Burla, Assistant Vice President, Associate Head-Corporate Ratings, ICRA.
The government will also review user-friendliness of trading platforms for corporate bonds, including issues arising out of capping of the International Securities Identification Number.