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The Union government’s ambitious bank recapitalisation plan for ailing public sector banks gathered momentum on Thursday after a proposal was submitted to Parliament to issue Rs80,000 crore worth of recapitalisation bonds.

The government, however, did not release details of the allocations to state-run banks. It has committed to spend Rs2.11 trillion to strengthen bank balance sheets hit by rising bad loans and ensure revival of credit flows to important sectors of the economy.

Markets welcomed the announcement, with state-run banks leading the rally in stock markets. The BSE Bankex was up 144.62 points, or 0.51%, at 28,777.47 points at the end of trading on Thursday. Stocks of Punjab National Bank, Bank of Baroda and State Bank of India were the major gainers, rising 5.97%, 3.77% and 1.72% respectively.

The government had initiated the process of capitalising state-run banks with several of them, including Central Bank of India, UCO Bank and Bank of Maharashtra, announcing capital infusion by the government over the past few days.

About Rs1.35 trillion was to be generated from the sale of so-called recapitalisation bonds and the balance Rs76,000 crore through budgetary allocation and fundraising from the markets. The proposal moved before Parliament suggests that the government has front-loaded the bond issuance programme, leaving only Rs55,000 crore of recapitalisation bonds for the next fiscal.

In its third supplementary demand for grants, the government said this expenditure will be met through enhanced receipts, implying that this additional expenditure may not push up the fiscal deficit.

The bonds will have non-SLR (non-statutory liquidity ratio) status, will be non-tradable and will be cash-neutral, said a person familiar with the development.

Market participants expect the government to follow the 1990s strategy, when these types of securities were first employed. The government issues recapitalisation bonds to banks in lieu of banks’ equity without triggering a cash outflow for the government.

Stronger capital will also improve the credit profiles of banks and enable them to tap markets at better valuations, according to analysts.

“It is a very substantial amount that the government has committed. It will reduce the pressure on the banking sector. As the stressed assets in the banking system reduce, banks will be in a much better position to lend. But demand for bank credit will depend on the revival of the investment cycle," said Anubhuti Sahay, head, South Asia Economic Research (India), Standard Chartered Bank.

The bond market expects that these bonds will be categorized in the held-to-maturity category of the investment book of banks, which is free from quarter-end mark-to-market provisioning. Being non-SLR securities, the impact on the bond market, especially government bonds, will be limited as it would dilute incremental demand for sovereign bonds.

Moody’s Investors Service said in a note on Thursday that the capitalization package will facilitate the two key policy initiatives of non-performing loan resolution and Basel III implementation. It expects “the government will allocate the INR1.5 trillion in capital across the country’s 21 public sector banks so that they will all have common equity tier 1 ratios above the minimum Basel III requirement of 8% by the end of March 2019".

Alka Anbarasu, a Moody’s vice-president and senior analyst, said the capital infusion will help state-run banks build their provision coverage ratio, allowing them to take haircuts on problem assets. “Such haircuts reflect one step in the regulator’s efforts towards a thorough clean-up of balance sheets across these banks," Anbarasu added.

Indian banks are weighed down by stressed assets close to Rs10 trillion. Of this, gross non-performing assets account for Rs7.7 trillion and the rest are restructured loans. The government and the Reserve Bank of India have aggressively used the Insolvency and Bankruptcy Code to free up funds of banks stuck in insolvent companies.

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