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Just not Enough

The Rs 22,915 crore injected into public sector banks will not be sufficient if we consider their severe asset quality deterioration, plunging profitability and low valuations.
By Anand Adhikari | Print Edition: August 14, 2016
Just not Enough
(Photo: Raj Verma)

Our country as a whole does not have capital. If a government has fiscal deficit, this means it doesn't have money. You are actually borrowing to put money in risk capital (equity of banks)."

This is how a former Reserve Bank of India (RBI) deputy governor responded to the recent government decision to inject Rs 22,915 crore into public sector banks or PSBs. This is nothing new. The government has been funding PSBs year after year (see The Annual Event). It has, over the past six years, given these banks close to Rs 90,000 crore, equal to the entire allocation for the rural sector in Union Budget 2016/17. "It's the worst type of funding," he says.

What he did not say is that given the poor performance of PSBs over the years - reasons include rising non-performing assets, or NPAs, because of high exposure to troubled sectors such as steel, power and infrastructure, besides sluggish credit demand - the capital allocated is grossly insufficient. It is, for instance, nowhere close to the Rs 1,42,730 crore gross NPAs that PSBs had to write off between 2011 and 2015. Also, future growth needs when the economy picks up and Basel-III norms mandating higher capital mean that PSBs require many times more than what the government is willing to pump in (Rs 70,000 crore by March 2019).

What is worse is that such capital injection is akin to throwing money down the drain as PSBs, which account for two-third of India's banking system, have been performing poorly for years. "No amount of capital will be sufficient if PSBs don't show tangible improvement in operational performance," says the former deputy governor.

Reasons For Recap

PSBs are under so much stress that they have reduced lending to prevent further capital erosion. This is keeping cost of funds high for companies and hitting the recovery in corporate earnings in spite of the RBI reducing benchmark rates several times in the past couple of years. The outgoing RBI Governor, Raghuram Rajan, hit the nail on the head when he recently said the slowdown in credit growth was largely due to stress in PSB balance sheets and not high interest rates. Banking sector credit growth has fallen from 20 per cent-plus to less than 10 per cent over the past few years.

So, why give PSBs capital when credit growth is sluggish? There are several reasons for this. One, they need money to clean up their balance sheets, necessary for pick-up in credit growth that is a must if India's economy is to pick up. Over the past four-five years, their capital adequacy ratio, or CAR, has fallen from 13.1 per cent to 11.6 per cent (the minimum level is 9 per cent). The reasons are rise in provisioning for NPAs, poor internal capital generation due to lower profitability, and low stock market valuations. State Bank of India (SBI) Chairperson Arundhati Bhattacharya has admitted that a part of the new capital - it has got Rs 7,575 crore, the highest among PSBs - will go into cleaning up the balance sheet.

Another reason is the RBI's asset quality review, or AQR, three months ago, in which a large chunk of restructured loans was re-classified as NPA. The AQR pushed up bank NPAs from 5.1 per cent of gross advances in September last year to 7.6 per cent in March this year. Higher NPAs mean higher provisioning (setting aside of funds) from profits which, along with low credit offtake, is pulling down profits of banks. This has dried up internal capital generation through profits. After the AQR phase, for which the deadline is March next year, PSB balance sheets will be much more cleaner, giving them space to start lending afresh. They could also get extra capital if restructured assets classified as NPAs and written off turn around and start repaying. This, of course, is a big if.

Kalpesh Mehta, Partner, Financial Services, Deloitte, says there could be some relief as banks are also converting loans into equity under the special debt restructuring scheme and the newly-introduced facility for converting unsustainable debt into equity or preference shares.

"The provisioning requirement is expected to come down gradually after March next year. Hopefully, PSBs will generate more cash accruals. This will also help (in higher valuation) as the market will take this into account while pricing the stock," says P.K. Gupta, Managing Director, SBI.

Future Growth

Given the level of stress in PSB balance sheets, low profits and near absence of options to raise money from the market, the amount the government has given is not sufficient for future growth. "The prospects of higher credit growth after the AQR and Basel-III norms (for minimum capital) mean these banks will require more capital," says Mehta of Deloitte. Already, retail loans, especially mortgages and unsecured loans, are showing good growth. Credit demand from SMEs is not bad either. The corporate sector, after some de-leveraging, is also coming to banks for working capital and other requirements. Exports, too, have stabilised after shrinking for nearly two years. The need for capital in such an environment cannot be overstated.

P. K. Gupta, Managing Director, State Bank of India

"The provisioning requirement is expected to come down gradually after March next year. Hopefully, PSBs will generate more cash"

ICRA has estimated that PSBs will require Rs 40,000-50,000 crore Tier-I capital this year. The Rs 23,900 crore, though provided at the beginning of the year, plus the Rs 1,100 crore that will come later, will not be sufficient. The NDA government has promised to provide Rs 70,000 crore by March 2019. The remaining money will come in 2017/18 and 2018/19. According to estimates, PSBs will need Rs 4,40,120 by March 2019 - Rs 2,39,720 crore Tier-1 capital, Rs 1,55,900 crore additional Tier-1 capital and Rs 64,500 crore Tier-II capital. The government, being their majority owner, will have to invest a big chunk of Tier-1 capital. For others, the banks can tap retail and institutional investors.

Kalpesh Mehta, Partner, Financial Services, Deloitte

"While nobody is talking of complete privatisation, there are options such as dilution of government stake and consolidation"

But what if banks fail to raise money from the market? In such a case, LIC can be a standby option. Banks are already finding ways to raise capital by selling non-core assets. The RBI has also allowed banks to revalue their real estate, a lot of which is at prime locations, to boost capital.

The government has mooted the idea of the RBI capitalising PSBs out of surplus funds. Rajan is not in favour of such a step. ?This seems a non-transparent way of proceeding, getting the bank regulator once again into the business of owning banks, with attendant conflict of interest," he said recently. Adds Mehta of Deloitte: "While nobody is talking of complete privatisation, there are options such as dilution of government stake and consolidation."

Experts say in a country whose economy depends on bank funds due to absence of an active corporate bond market, the government has no option but to support the banking sector. However, like the former deputy governor said, a capital-starved country with both current account and fiscal deficits cannot afford to put taxpayer money down the drain either. Ultimately, banks will have to use capital efficiently. This can happen only if they follow a professional approach. The Banks Board Bureau under Vinod Rai is already on the job to put the right people at the helm to improve governance. "It's high time PSBs become self-sustained and return capital to the government, which needs it the most for kick-starting the economy," says a consultant. And, if nothing works, privatisation is the best way to get rid of inefficiencies.

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