A budget for the banking sector

Overall, estimated capital requirement for the banking system is between Rs2.5 trillion and Rs3 trillion over the next four years compared with the government’s promise of Rs70,000 crore


Graphic The capital requirement will grow as most banks are yet to recognize some more bad loans. Photo: Mintby
Graphic The capital requirement will grow as most banks are yet to recognize some more bad loans. Photo: Mintby

An investment recovery and the health of the banking system are inextricably linked. The banking industry needs cash. Bloated with bad loans, state-owned banks require Rs.1 trillion in the near term, estimate brokerage firms and rating agencies. The government, on the other hand, has allotted only Rs.25,000 crore for this year under its so-called Indradhanush programme.

Consider this statistic: In the December quarter alone, banks posted a cumulative loss of Rs.10,911 crore, which is slightly over two-fifths of government’s proposed capital infusion. Credit Suisse estimates that unprovided problem loans are now at 65-200% of public sector banks’ capital.

The capital requirement will grow further as most banks are yet to recognize some more bad loans. The chart shows how badly banks need capital. Overall, estimated capital requirement for the banking system is between Rs.2.5 trillion and Rs.3 trillion over the next four years compared with the government’s promise of Rs.70,000 crore.

Clearly, given its fiscal constraints the government may not be able to cough up any huge amount upfront, especially after the Seventh Pay Commission and 14th Finance Commission recommendations. The solution to the bad loan problem, which will free up cash for banks and enable them to accumulate it out of profits, lies in policy measures.

A comprehensive bankruptcy code was promised in the last budget; it is in the works and yet to become law. Another idea that has taken hold in recent times is the creation of a “bad bank”, some version of the US’s Troubled Asset Relief Programme after the 2008 crisis. This would be a sovereign-backed asset reconstruction company. But that doesn’t save taxpayers from taking a hit as someone would have to make good those losses. It also creates a moral hazard as banks aren’t made liable for their past bad decisions.

Of course, the government can reduce its stake below 51% in public sector banks. It can always bring down its stake to 33% while still keeping voting rights intact.

The big concern here is cheap valuations currently and hurdles from bank unions and accusations of selling the family silver. That would be the first step in injecting some much-required capital.

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