Banking stress: Government needs to move faster

The movement in the clean-up sequence, i.e. equity infusions to protect capital levels of banks and rapid resolution of stressed assets, is still to gain momentum


Under the Indradhanush programme, Rs25,000 crore each will be infused in PSBs in FY16 and FY17 by the government. Photo: Bloomberg
Under the Indradhanush programme, Rs25,000 crore each will be infused in PSBs in FY16 and FY17 by the government. Photo: Bloomberg

Six months have passed since the true value of public sector banks’ (PSB) assets was fully recognized after a rigorous quality review. A key outcome of this is a 2.2 percentage point jump in the gross non-performing asset (NPA) ratio in two quarters to March 2016. This wasn’t unexpected, although the extent of increase appears to have surprised. Likewise, losses and a large drop in profits and market capitalization of PSBs were also anticipated.

However, the movement in the clean-up sequence, i.e. equity infusions to protect capital levels of banks and rapid resolution of stressed assets, is still to gain momentum. The danger of long lag and inadequate response is that of stretching the cycle of balance sheet repair, which is a must for normal activities to resume. The International Monetary Fund’s latest appraisal, for instance, holds that “headwinds from weaknesses in India’s corporate and bank balance sheets” could pull down growth. 

It is not that there haven’t been efforts, but they are far too modest and inadequate relative to magnitude required. This is particularly true seeing the larger-than-expected jump in NPAs last quarter, where a more worrying fact was the uncertainty of banks’ managements that the Rs.5.8 trillion stock of bad loans as of March 2016 could indeed rise further. 

There have been many reports of large-scale resolution options, for example, setting up a stressed assets’ fund or a national bad bank. The government is said to be examining these, but concrete action is still awaited. Fresh bank-level efforts have focused on modifying rules to enable easier conversion of some of a firm’s loans into equity-like instruments by banks (Scheme for Sustainable Structuring for Stressed Assets or S4A).

A sector-specific approach is being pursued to help cyclically-affected borrowers, assuming that such partial revival will restore the health of these stressed assets. For example, import tariff protections to the steel industry and some elements of the comprehensive measures for the apparels segment. Welcome as these are, it will take a while to feed through to both firms and banks—some are contingent upon the overall economic state, including the external environment. 

Capital support commitments are still bound at Rs.25,000 crore; of this, Rs.22,915 crore will be injected straightaway. These plans, however, were devised and announced back in mid-2015—before the asset quality review, or the first step of the balance sheet clean-up process, began. Under the Indradhanush programme, Rs.25,000 crore each will be infused in PSBs in FY16 and FY17 by the government and Rs.10,000 crore each in the next two years. The limited capital provision is all the more surprising seeing the unexpected jump in NPAs last quarter. That Basel III requirements must also be met by March 2019 further underscores the inadequacy which has been noted by all analysts and rating agencies. 

There also seems an uncommitted approach to structural reforms in the overall banking sector, which by itself has the capacity to uplift market valuations that would then enable PSBs to raise funds from the capital market. For instance, the unconditional capital allocation (to support credit growth, while only 25% is tied to efficiency parameters) indicates retreat from Indradhanush plan of restricting equity infusions to only well-managed banks. There is absence of progress in accountability and governance improvements and no enthusiasm about reducing government shareholdings in these banks. 

Balance sheet strains weigh upon both firms and banks, which is not in the overall economic interest. 

Renu Kohli is a New Delhi based economist. 

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