While Reserve Bank Governor Urjit Patel Wednesday termed the government’s capital infusion package for banks as “a monumental step forward in safeguarding the country’s economic future”, Finance Ministry officials indicated that the government is likely to allocate funds differentially and will prioritise capital allocation to strong lenders. The weaker banks may have to either shrink in size or not grow from the current position.
Of the total of 22 PSU banks, as many as eight currently have gross non-performing assets (GNPA) above 15 per cent while 14 banks have GNPA of more than 12 per cent.
A day after the Centre announced capital infusion of Rs 2.11 lakh crore (of which the banks will raise Rs 58,000 crore from the market), a differential and selective approach for capital infusion emerged as the key takeaway in the proposed exercise.
Chief Economic Advisor Arvind Subramanian said there is a possibility to shrink or narrow the scope of unviable banks. “There is a view that there are too many banks and a few unviable ones. The aim must be to shrink or narrow the scope of the unviable banks as former RBI Governor Y V Reddy has argued,” he said in a lecture at the SGTB Khalsa College.
In this view, recapitalisation must be selective and incentive-based, directing it to those banks where the bang-for-buck in terms of new credit creation will be maximum. Since all banks must maintain a minimum capital adequacy, one possibility would be to recapitalize the unviable banks only to the extent necessary to finance their current balance sheet size while explicitly not providing for their growth, Subramanian added.
The government’s mega bank recapitalisation plan is likely to push up its debt levels, repayment obligations and bond yields while rating upgrade chances would be pushed back, experts said.
Also, as the recap bond is a cash-neutral transaction, the fiscal deficit will be impacted only by the interest cost on the bonds that the government pays every year. Bank shares on Wednesday soared sending stock indices to record highs. The benchmark Sensex breached the 33,000-mark for the first time while Nifty ended at a fresh lifetime high with bank shares, led by SBI, surging by over 27 per cent, PNB jumped over 46%.
The 30-share Sensex surged 435.16 points, or 1.33 per cent — its biggest single session gain since May 25 when it had surged 448.39 points — to close at a new peak of 33,042.50. The broader 50-share Nifty finished at its fresh lifetime high of 10,295.35, up by 87.65 points, or 0.86 per cent.
RBI Governor Patel, in a statement on Wednesday, also said that banks that are in a better shape can be given priority by the government in giving capital.
The recapitalisation bonds will be liquidity neutral to the government and will front-load capital injections while staggering the attendant fiscal implications over a period of time, he said. “It will allow for a calibrated approach whereby banks that have better addressed their balance-sheet issues and are in a position to use fresh capital injection for immediate credit creation can be given priority while others shape up to be in a similar position. This provides for a good way of bringing some market discipline into a public recapitalisation program compared to the past recapitalisation programs,” Patel said.
Banking Secretary Rajiv Kumar said the government will follow a differential approach while infusing equity in the public sector banks, which will take into account their performance and adherence to prudential norms.
The government has so far signed memorandum of understanding with 11 banks that link capital infusion to their operating performance. These agreements require banks agree to certain business turnaround initiatives, reduce NPAs, generate adequate return on assets and capital employed, in order to be considered for getting capital.
While allocation of capital will be selective, the key features of recapitalisation bonds are not yet clear. The Centre has the option to either issue these bonds itself which are then subscribed to by the banks and the money so raised is allocated as equity to the state-owned banks. Other option could be to float a special purpose vehicle backed by the Central government that issues the recapitalisation bonds.
It is not yet clear whether issuance of such bonds will add to the Central government’s fiscal deficit but it will certainly increase the overall debt and bonds will need to be repaid or converted into equity at the time of redemption. UBS Securities India Pvt Ltd said that recapitalisation of PSU banks may create a supportive environment for growth but may not drive it.
“This should be a boost for equity market sentiment, as it fuels growth recovery hopes. The recapitalization amount seems adequate and may create a supportive environment for growth, but it may not drive growth by itself — currently weak credit demand reflects economic activity, not just the capital adequacy of (state-owned) banks,” UBS Securities said in a research note on Wednesday.