PSU banks: Will the new govt privatize?

The banking community is closely watching the Bharatiya Janata Party’s (BJP’s) stance on privatization. A conservative estimate of the capital requirement of India’s banks is around ₹ 2.5 trillion over the next three years and the government-owned banks account for at least 70% of the industry. Where will the money come from? The government expects to contain its fiscal deficit for 2013-14 at 4.6%, and has set a 4.1% target for 2014-15. It’s pretty evident that the government’s ability to infuse capital into its banks is limited. Will the new government that comes to power after the general elections in April-May (and many believe that the BJP will form the next government) change the law and bring down the government stake in public sector banks to below 51%?

Finance minister P. Chidambaram has ruled out the possibility of doing so. After a meeting with the chiefs of India’s public sector banks early this month, he had said the government would consider all options of capital raising for state-owned banks, including issuing shares to employees, rights issues to minority shareholders and greater participation of pension and insurance funds, to ensure that the capital needs of banks are met. Till recently, Chidambaram had been harping on banks ploughing back profits, after paying dividends to shareholders, to prop up their capital which anyway they have been doing.

Chidambaram has earmarked ₹ 11,200 crore for recapitalizing public sector banks next year, lower than the ₹ 14,000 crore in the current fiscal year. Global rating agencies have cautioned that the limited capital infusion is credit-negative for banks. Moody’s Investors Service Inc. said the capital allocation made as part of the interim budget is “much smaller” than its estimate of ₹ 25,000- ₹ 36,000 crore required by India’s public banks to meet a minimum equity capital ratio of 8% under global Basel III norms by 2018. Standard and Poor’s too said that Indian banks will need sizeable capital to support growth and meet capital requirements while indicating that the private sector banks are better placed in terms of meeting the international capital norms.

Under Basel III norms, being implemented in phases between April 2013 and March 2018, banks need to have a 8% core capital ratio and total capital adequacy ratio of 11.5% against 9% now.

The capital requirement is magnified as bad assets of public sector banks have been ballooning. Banks do not earn interest on bad assets and, on top of that, they need to set aside money. That impacts their profitability. Moody’s expects the bad loans to continue to rise in fiscal 2015 and says the public sector banks’ need for significant external capital is a result of an increase in bad loans in a slowing economy. Gross bad loans of Indian banks rose to ₹ 2.4 trillion in the December quarter and the combination of bad and restructured loans roughly account for around 11% of the total loans of Indian banks.

It’s difficult to assess the exact capital requirement but the Reserve Bank of India (RBI) has made some quick estimates, based on a 20% annual credit growth rate. In September 2012, then RBI governor D. Subbarao had said the banking sector would need around ₹ 5 trillion capital, of which equity capital would be ₹ 1.75 trillion. Of this, between ₹ 70,000 crore and ₹ 1 trillion can be raised from the market. This may not be a difficult task as between 2007 and 2012, banks had raised equity capital to the tune of ₹ 52,000 crore from the primary markets. By RBI’s estimate, if the government opts to maintain its shareholding at the current level, the burden of recapitalization will be of the order of ₹ 90,000 crore; if it decides to reduce its shareholding in every bank to a minimum of 51%, the burden reduces to less than ₹ 70,000 crore. However, the scene will be radically different if the government is open to the idea of reducing its shareholding in public sector banks to below 51%. This can be done while protecting its majority voting rights. Chidambaram has ruled out the possibility but will the new government be willing to do that?

Indeed, equity can be raised from the market but the latest equity issue of the State Bank of India (SBI), the nation’s largest lender, has made it amply clear that the market does not have a healthy appetite for public sector bank stocks as they are saddled with a pile of bad loans. The shadow of the government on many of their lending decisions is also held against them. SBI wanted to raise ₹ 9,600 core from institutional investors but had to settle for ₹ 8,032 crore and Life Insurance Corp. of India picked up 41.3% of the total shares offered. If the government wants the public sector banks to be rerated by the market, it needs to bring down its stake below 51%.

The other option could be creation of a bank holding company—a sort of special purpose vehicle—by transferring the government stake in public sector banks. Institutional investors and private equity funds can be invited to pick up stakes in the holding company which can raise money from the market periodically whenever the banks need equity infusion. The public sector banks will be rerated and their valuation will rise once the government ceases to own them directly. This will ensure success of their equity raising efforts in the market.

The banking industry’s credit growth has been 11.4% in the current fiscal year till the third week of February, marginally higher than 11.2 last year, but this must go up to at least 20% to bring back the Indian economy on a high growth path. To support that kind of credit growth, the banks need capital and the creation of a holding company could be the best solution at this point of time.

Tamal Bandyopadhyay keeps a close eye on everything banking from his perch as Mint’s deputy managing editor in Mumbai. He is also the author of A Bank for the Buck, a book on HDFC Bank. Email your comments to bankerstrust@livemint.com