Capital infusion: Prepping strong banks to acquire the weak

Well capitalised banks can better absorb weak ones and can also speed up NPA resolution as they will have resources to write down potential losses.

Written by Sunny Verma , Aanchal Magazine | New Delhi | Updated: October 31, 2017 7:30 am
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The mega recapitalisation of state-owned banks will begin with the Centre infusing greater capital in larger and stronger lenders, thus preparing them to take over smaller and weaker banks. Even as the government plans to prepare the broad contours of the recapitalisation bonds in a couple of weeks, senior finance ministry officials said the stronger PSBs, helped by capital support, will be better equipped to consolidate weaker banks.

The Centre last week announced plans to inject Rs 2.11 lakh crore of equity in the PSU banks — comprising of Rs 1.35 lakh crore via recapitalisation bonds, Rs 18,000 crore from budgetary resources and Rs 58,000 crore to be raised by banks from the market. Contrary to expectations of consolidation taking a backseat post the announcement of capital infusion, the government will strengthen the larger banks while at the same time priming them for taking over weaker ones, a finance ministry official said.

Finance ministry officials — including Chief Economic Adviser Arvind Subramanian, Banking Secretary Rajiv Kumar — and the RBI Governor Urjit Patel have indicated the Centre’s plan to adopt a differential and selective approach for infusion. While strong banks will get greater capital, weak banks may have to either shrink in size or not grow from the current position.

Out of the total 22 PSU banks, as many as eight currently have gross non-performing assets (NPAs) above 15 per cent and 14 banks have GNPA of more than 12 per cent. Indian Overseas Bank, Uco Bank, Dena Bank, United Bank of India and Corporation Bank are among those that have Gross NPA ratio of above 15 per cent. These banks could be first in the line in case larger banks propose acquisitions. As for the IDBI Bank, which has the highest GNPA ratio of 24.1 per cent, the government is expected to follow a different strategy, of strategic sale to private investors.

In August, in order to expedite consolidation, the Cabinet had approved a framework for consolidation among PSBs, including a proposal to set up an Alternative Mechanism, comprising of senior government ministers and headed by finance minister Arun Jaitley, to create strong banks. Banking secretary Kumar said in a tweet on Monday: “Govt. walks the talk on banking reforms; constitutes Alternative Mechanism for PSBs consolidation; FM to head.”

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As per the consolidation framework, merger decisions should originate from the banks and these should be based on commercial decisions. The proposals received from banks for in-principle approval to formulate schemes of amalgamation shall be placed before the Alternative Mechanism, and after in-principle approval, the banks will take steps in accordance with the Securities and Exchange Board of India requirements.

Banks that are well capitalised will be able to better absorb the weak banks through consolidation, the official said. Country’s largest lender State Bank of India last year completed the process of merging State Bank Of Bikaner & Jaipur, State Bank Of Hyderabad, State Bank Of Mysore, State Bank Of Patiala and State Bank Of Travancore and Bharatiya Mahila Bank with itself.

Equity infusion will also enable banks to speed up the process of bad loan resolution as they will have the resources to write down potential losses. “Put the money in, then the resolution will also happen quicker because resolution is also held up by the fact that banks don’t have money. We put in money, government stake will go up, and it improves the health of banks by selling it (government stake),” said another official.

Resolution of bad loans, recapitalisation of banks and consolidation have to work alongside other reforms for creating a banking system that is geared up to support economic growth and increase credit deployment in the economy, the official said.

“Because resolution on one part is happening and the banks clean up the balance sheet, you recapitalise the banks, you can take it off either by being part of this IBC process or you can do another process, like NIIF, but this can now carry on because banks will get cleaned up. That needs to happen. And we are putting in money ( to support loan write off) so that obviously you fill the hole,” he said.

Bad loan resolution helps the government in realistically estimating the capital requirements of the banks. “Depending on as and when these things get resolved, you take an assessment of how much money you will get from there (resolution). Conceptually, what you do is suppose you are holding a Rs 100 stressed asset, let’s say you will provision Rs 20. And supposing you say that you will basically recover Rs 30, that means you have to add capital of Rs 100-20=Rs 80 and then Rs 80-30=Rs 50…and so you take off the whole loan except what you see as being recovered. And then you add to capital and then balance sheets clean and this process works,” the official said.

Cleaning up of the balance sheets and injection of capital will mean that banks have the wherewithal to absorb any transitory shocks that may arise from merger of the weak banks. RBI Governor Urjit Patel had echoed the same view in April that the banking system could be better off if some public sector banks are consolidated so as to have fewer but healthier entities. Patel had also said that consolidation of banks could also entail sale of real estate where branches are redundant as well as offering voluntary retirement schemes to manage headcount and adding younger, digital-savvy personnel.

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