The Reserve Bank of India's corrective action framework for weak banks is akin to taking an injured athlete to bed rest," explained a Reserve Bank of India (RBI) deputy governor last year when bank customers started worrying about close to a dozen public sector banks (PSBs) facing regulatory interventions, the most prominent being the prompt corrective action (PCA) scheme. The PCA framework is triggered when a bank's three critical parameters - asset quality, return on assets (RoA) and capital adequacy - fall below a threshold. It leads to restrictions on payment of dividend, setting up new branches, fresh hiring, etc., to restore the bank's health. The RBI has put 11 out of 27 PSBs - which together account for three-fourth of the banking assets - under the PCA framework.
But can the RBI's care help these banks get back into health? Considering that the first bank to go under the PCA, United Bank of India (UBI), in 2014, is still not fit enough to be discharged from the RBI's critical care, the answer cannot be a clear yes. Similarly, three years ago, the RBI had triggered corrective action on Chennai-based Indian Overseas Bank. The bank is still unsure when it will get to exit as its performance parameters are still in the red (See The PSB XI).
The situation is gradually slipping out of the RBI's hands. Last week, it put harsh restrictions on two PCA-referred banks, Dena Bank and Allahabad Bank, after their finances further deteriorated. Under the PCA framework, the RBI has discretionary powers, which start with milder sanctions and can even lead to punishing restrictions such as directing the bank to halt lending. Dena Bank, for instance, has been told not to do fresh lending. There are also restrictions on fresh hiring. Allahabad Bank, too, has been asked not to raise costly deposits, invest in non-banking assets or lend to borrowers with high risk.
This is just the tip of the iceberg. Three more large PSBs, with total balance sheet size of close to Rs20 lakh crore, are expected to come under the PCA. The critical parameters of New Delhi-based Punjab National Bank have reached PCA threshold levels after the alleged Rs11,000 crore Nirav Modi fraud. It reported a net loss of Rs12,282 crore in 2017/18 with gross non-performing assets (NPAs) at 18.38 per cent of advances at Rs86,620 crore and capital adequacy ratio of 9.20 per cent as against the RBI threshold of 9 per cent. The RoA is minus 1.60 per cent. Mumbai-based Union Bank of India is another likely PCA candidate. For 2017/18, it reported a net loss of Rs5,247 crore, gross NPAs of Rs 49,369 crore, almost 15.73 per cent of advances, capital adequacy ratio of 11.50 per cent and RoA of minus 1.07 per cent.
A Bit Overaggressive
Over the last few years, banks, including the private sector ones, have been under huge pressure due to deteriorating asset quality, poor credit off-take and overleveraged companies. This hit PSBs more because of their high reliance on corporate lending and higher exposure to troubled sectors such as infrastructure, power, steel and textiles. PSB bankers say the RBI did not help and instead sought higher provisioning for NPAs. The measures included asset quality review under which the RBI asked banks to make provisioning for stressed accounts (not necessarily NPAs in their books) as if they were NPAs. The up to 50 per cent provisioning for companies referred to the National Company Law Tribunal under the new Insolvency and Bankruptcy Code (IBC) also worsened the financial position of banks. The recent move to scrap all restructuring schemes such as corporate debt restructuring, strategic debt restructuring, S4A and 5/25 - and making IBC the overarching framework for debt resolution and bankruptcy - is pushing more assets into bankruptcy. Apart from this, there are quite a few power projects that are a fit case for liquidation. In liquidation cases, banks have to make 100 per cent provisioning. Given the RBI's plan to resolve every NPA case under the IBC, there is a likelihood of banks having to make a total provisioning of over Rs4 lakh crore in the coming years. Banks are expected to continue reporting massive losses in 2018/19, too.
"Increase in provisioning will hurt profitability. Weak PSBs, in particular, will continue to report losses," said a recent Moody's Investor Service report. The report pointed at a silver lining, too. "The near-term impact of this will be largely offset by planned capital infusion from the government," Alka Anbarasu, Vice President and Senior Analyst at Moody's, said in the report. The government has allocated Rs2.11 lakh crore through budgetary support, recapitalisation bonds and equity raising for PSBs for the next two years.
The government is being magnanimous as this is an election year and PSBs play a big role in the social sector. It is also talking about asking the RBI to ease the PCA framework a bit. The government is also concerned about credit flow to SMEs and MSMEs where few players apart from PSBs lend. But experts say the government and the RBI need to do more. "The issue is relaxing the stringent provisioning requirement for IBC cases and not forcing banks to take companies to IBC. This judgment [whether to take a company to the NCLT] should be left to PSBs as there are ways to resolve a bad asset out of IBC," says a consultant with a Big Four accounting firm.
With more than half the PSBs under PCA, loans to the corporate sector have substantially dried up. With PSBs vacating the space, private banks with sufficient capital are lending to companies, though cautiously. "We are selective. Wherever there are good clients, we are doing refinancing," says a corporate head of a private bank.
The Way Forward
The immediate option for PSBs is to step up recovery efforts by using the IBC. Retail banking is another area where PSBs can scale up operations, both by expanding the existing basket and exploring new products. Today, private sector banks are expanding retail banking at a fast pace, which is making up for losses on the corporate side. Retail banking areas such as consumer durables financing and affordable housing also offer scope for growth. There is also a huge potential for increasing fee income. Treasury is another area they can look at. Many have non-core assets which can be sold. For example, IDBI Bank, one of the 11 PCA-referred banks, plans to raise Rs5,000 crore by selling non-core assets.
There are also long-term solutions for which the government will have to move fast. The Bank Boards Bureau (BBB), set up to improve governance at banks and selection of top management, including boards, has completed two years but has not been able to come up with a future road map. "We need to have a long-term strategy for PSBs. This includes clear capital infusion plans and governance and human resources reforms," says A.K. Khandelwal, former chairman of Bank of Baroda who was also a BBB member.
While the government has made some progress in banking reforms, such as splitting the post of chairman and managing director, PSBs have done little for inducting specialists from technology, risk management and cyber security fields on boards. Bankers say they are implementing a reforms agenda decided by the Indian Banks Association and the government, which includes digitisation and human resources reforms. But they will have to move fast and take some risks. The competition from fintech players and payments and small finance banks is already staring at them. PSBs, say industry exports, should engage more with fintech players and use financial services aggregators to market their products.
If things don't improve, there will be a need for drastic measures such as merger of PSBs to create five-six large banks of global size.