New Delhi: The government plans to infuse 70,000 crore into state-run banks over the next four years to reinforce their capital base, help them meet demand for credit and adhere to new international standards that will take effect by the end of 2017, signalling a rethink of its strategy.

The National Democratic Alliance government will provide public sector banks 25,000 crore this fiscal year and again in 2016-17, and 20,000 crore over 2017-18 and 2018-19, the finance ministry said on Friday.

“Allocation for first-year recapitalization is adequate," Reserve Bank of India (RBI) governor Raghuram Rajan told reporters after meeting finance minister Arun Jaitley in New Delhi. “It’s a good beginning," he added.

This year’s allocation marks a threefold increase over the 7,940 crore the government set aside for topping up bank capital.

Concerns raised by RBI and the banks may have prompted a rethink by the government, analysts said. The fact that the government’s plan to reduce its stake in state-run banks to 52% failed to take off because of the low valuations of these lenders, given their heavy bad-loan burden and weak balance sheets, may have bolstered the banks’ case.

The finance ministry also reiterated its intent to keep the lenders sufficiently capitalized to meet the so-called Basel III standards that require banks to maintain higher capital to fend off future crises.

Still, the government is hoping that with an improvement in banks’ balance sheets as the economy recovers, they will be able to raise the remaining 1.1 trillion from the markets.

“We estimate that PSBs’ (public sector banks’) market valuations will improve significantly due to (i) far-reaching governance reforms; (ii) tight NPA (non-performing asset) management and risk controls; (iii) significant operating improvements; and (iv) capital allocation from the government," the finance ministry statement said.

“Improved valuations coupled with value unlocking from non-core assets as well as improvements in capital productivity will enable PSBs to raise the remaining 110,000 crore from the market," the statement said.

Most state-run banks have had their profitability dented because of a steep increase in bad loans and restructured loans, requiring them to set aside more money to cover the risk of default. Stressed advances at scheduled commercial banks rose to 11.1% of total advances in March from 10.7% in September, according to the Financial Stability Report released by RBI last month.

The report warned that asset quality of state-run banks will get worse before it gets better. The report said gross NPAs of banks may increase to 4.8% by September from 4.6% in March before moderating to 4.6% by March 2016.

The 25,000 crore earmarked for this fiscal year will be allocated in three tranches. Forty per cent of the funds will go to those banks that require capital support, with the government striving to ensure that all banks maintain a capital adequacy of 7.5% (tier-I capital) by the end 2015-16.

Capital adequacy is an indicator of the financial strength of banks, expressed as the ratio of capital to risk-weighted assets.

Forty per cent will be allocated to the top six state-run banks—State Bank of India (SBI), Bank of Baroda (BoB), Bank of India (BOI), Punjab National Bank, Canara Bank and IDBI Bank Ltd “in order to strengthen them to play a vital role in the economy", the statement said.

The remaining 20% will be allocated depending on the performance of state-run banks in the first three quarters of this fiscal year.

“This will incentivize them to improve their performance in the current year," the government said.

On Friday, through the supplementary demand for grants, the government sought an additional 12,000 crore for capitalizing state-run banks. The remaining 5,000 crore will be sought in the second supplementary demand for grants later this year.

“Whether 70,000 crore would be enough for the banking industry or if we will be able to raise 1.1 trillion from the market will depend on the rate at which the economy grows and how soon we can see good pickup in demand. It would be difficult to project for four years as there are so many moving parts," said Arundhati Bhattacharya, chairperson of SBI.

R.P. Marathe, executive director of BOI, said the bank alone has a capital requirement of 25,000-30,000 crore in the next four years.

“By that logic, 70,000 crore would not be enough to cover for the capital needs of the entire banking industry. The government should consider divestment as an avenue to make capital available to banks. Even though public sector banks have low market valuations at this point in time, things will improve as the economy recovers and that can be a good time to divest. If not, then the government should be up for infusing as much capital as required by banks," he said.

R.K. Takkar, executive director of Dena Bank, said 70,000 crore in the next four years should be able to meet the requirements of state-run banks.

“In these four years, the markets should also improve, allowing us to raise the remaining 1.1 trillion. We had requested the government for 500 crore keeping in mind the 15% credit growth we are expecting this year and we are expecting that to come to us," he said.

The government’s announcement, made during market hours, caused bank stocks to rise, with the BSE Bankex gaining 1.68% on a day the benchmark Sensex rose 1.48%.

Among state-run banks, shares of SBI and BoB rose by 5.25% and 5.34%, respectively on BSE.

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