Insights into Editorial: Will bank recapitalisation fix NPAs?

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Insights into Editorial: Will bank recapitalisation fix NPAs?


Will bank recapitalisation fix NPAs?

Context:

The Centre unveiled an ambitious plan to infuse ₹2.11 lakh crore capital over the next two years into public sector banks (PSBs). 1.35 lakh cr. will be through sale of recapitalization of bonds. This sum is more than one-third the tier I or core capital (equity plus reserves) of public sector banks (PSBs) and the equivalent of about 1.25% of gross domestic product (GDP).

PSBs are burdened with high, non-performing assets. Indiscriminate lending earlier by banks may be the main reason for high level of NPAs (non-performing assets).

The government’s capitalisation package for public sector banks will provide a strong booster dose of relief for the capital starved public sector banks.

What are the causes of deceleration in credit growth?

  1. Poor demand:

Some observers ascribe the deceleration in credit growth to poor demand. They say that corporates have excessive debt and are in no position to finance any investment. This may be true of large corporates.

  1. Supply of credit:

The government has realised that there is a problem with the supply of credit. It has to do with PSBs’ inability to lend for want of adequate capital.

  • Market estimates had placed the requirement of government capital at a minimum of ₹2lakh crore over a four-year period.
  • In 2015, under the Indradhanush Plan, the government chose to commit a mere ₹70,000 crore over the period.
  1. PSBs, unlike their private sector counterparts, had lent heavily to infrastructure and other related sectors of the economy. Following the global financial crisis of 2007, sectors to which PSBs were exposed came to be impacted in ways that could not have been entirely foreseen.
  2. The failure to quickly recapitalise PSBs has adversely impacted the economy.
  • It has hindered the effective resolution of the NPA problem and kept major projects from going through to completion.
  • Corporates are stuck with high levels of debt and are unable to make fresh investments.

Why did government take the route of recapitalizing PSBs?

With India’s economic growth faltering in the last couple of years, the government has been casting about for ways to galvanise the economy like Demonetisation and introduction of GST. Its economic benefits will be long in coming while the short-term disruption has been very real.

  • Bank’s capital adequacy ratio (CAR) has become adverse.
  • The recovery process set up through the Insolvency and Bankruptcy Code (IBC) reform had not been working at the desired pace.
  • PSBs are facing the prospect of having to take haircuts on loans stuck in insolvency proceedings.
  • The size of the haircuts the banking system is expected to become more expensive in terms of capital in the banking system.
  • Till the recovery process gathers momentum, more capital would be required. There is also a time dimension associated with this equation.
  • Enhancing the flow of credit is critical for revitalising India’s growth momentum at a time when the global economy is recovering.
  • Private investments remain elusive in the face of the “twin-balance sheet problem”.
  • If banks do not have adequate capital, they cannot lend. This would dampen the economy.

What is a ‘Haircut’?

A haircut is the difference between the market value of an asset used as loan collateral and the amount of the loan. The amount of the haircut reflects the lender’s perceived risk of loss from the asset falling in value or being sold in a fire sale.

What is the source of funds for Recapitalization by government?

  • Of the ₹2.11 trillion package, ₹1.35 trillion will be towards issue of recapitalisation bonds. PSBs will subscribe to these bonds. The government will plough back the funds into banks as equity.
  • Another ₹180 billion will be provided as budgetary support.
  • The remaining ₹580 billion will be raised from the market.

Analysts believe the package should enable banks to provide adequately for NPAs and support modest loan growth.

Criticism on Recapitalization

  • This measure is not going to result in the recovery of bad loans.
  • It is a very temporary solution and only treats symptoms and not what causes these symptoms.
  • The IBC (Insolvency and Bankruptcy Code) is only a ploy to extend favours to big corporates to escape from their liability at the cost of the public exchequer.
  • It is labelled as inefficient and incompetent. If banks would have recovered these loans, their interest revenue would have been more; and they would have generated capital internally out of the profit.
  • The proposed recapitalisation bonds are likely to add to the fiscal deficit.

Other measures to revive bank credit:

The last thing the economy and the banking system can afford is a further drop in economic value. There will have to be more reforms to put a higher order of governance in the banking sector.

  1. Tenure and remuneration of senior management:
  • For improving governance of PSBs, questions like the tenure of senior management have to be addressed.
  • Public Sector Bank chiefs and their managing/executive directors must have a fixed tenure of at least five years.
  • Offer incentives by way of very good annual bonus based on performance would enable them to take the right decisions.
  • Political and economic influence on senior management decisions should be avoided.

 

  1. Adopt best practices
  • Lateral entry at the level of general managers and not at the ED/MD level.
  • The banking boards need to be manned by professional directors rather than political nominees.
  • Accountability needs to be fixed by removing senior management for non-performance.
  • Create a framework for funding of projects to be undertaken by one bank which down sells it within a period of 90 days, but could breach exposure limits in that period.

 

  1. Fill the gaps in the regulatory framework
  • One of them is joint lending. Borrowers borrow from one bank and go to another and borrow money. Banks do not talk to each other. Also, there are issues in getting loans approved for large projects. Borrowers have to run to 20 banks to get a sanction, which is uneconomical, costly and leads to corrupt practices as bank officials seek favours to agree to a proposal.

 

  1. The appointment of statutory auditors
  • Shortlisted auditors by promoters should be assessed by the Audit Committee and Board.
  • In case of wrong reporting, these have to be punished by prohibiting them to audit any financial entity regulated by the RBI, the Securities and Exchange Board of India, the Insurance Regulatory and Development Authority and the Pension Fund Regulatory and Development Authority.

 

  1. Action must be taken against promoters who have siphoned off funds and transferred them to their personal assets.

 

  1. Needed one Quick action plan
  • NPA cases caused by the cyclical nature of the sector need to be supported if there are no issues with fund utilisation.
  • Deal with NPAs sector by sector like power, roads, steel and so forth.
  • We need to pick NPAs from PSBs of each sector, park them in one place by creating an entity like a SUUTI (specified undertaking of the Unit Trust of India), fund the banks and invite international and national investors to dispose of the assets.
  • The system will have to conduct more analysis, more evaluation sector-wise in terms of its potential for value restoration and enhancement.

Conclusion

In the last three years, banks have written off ₹1,88,287 crore. We have to bear in mind that when banks lose money or when the government recapitalise PSBs, it is all people’s money and out of public savings kept in trust in the banks. People’s money should be for people’s welfare and not to fund corporate default or to recapitalise the banks to adjust these bad loans.

This capital infusion is a welcome step but there are issues that should have been dealt with first. The good part is that after putting this capital, the government’s equity would be close to 70-80% in each PSB. The government could make a huge profit by selling this equity after improving the management of PSBs.

Recapitalisation could give the banking system a good breathing time to enhance its credit portfolio and restore value out of the NPA accounts.