Capital crisis at financial institutions to test new government’s reforms agenda4 min read . Updated: 29 May 2019, 11:22 PM IST
- Twelve of the 18 state-owned banks that reported losses in Q4FY19 have eroded their capital base
- The new govt's focus is expected to be on reviving the business cycle and unclogging the financial system
Mumbai: Fixing the capital crisis faced by financial institutions will be key to the success of the economic programme of the new government that takes office on Thursday.
A continued capital shortage could slow down the reforms agenda of Prime Minister Narendra Modi in his second term and further delay an economic recovery.
Fresh capital will be required to recapitalize weak state-run banks and spur non-banking financial companies (NBFCs) to resume lending. They have virtually stopped lending thanks to a pileup of bad loans and asset-liability mismatches.
Capital inflows and sufficient systemic liquidity will also provide confidence to local institutional investors such as mutual funds and households to invest in upcoming share sales. The government also needs to restart spending to revive economic momentum.
The government’s cash balance with the Reserve Bank of India (RBI) rose to ₹1.07 trillion on 2 April from just ₹1,988 crore on 23 January, indicating a spending squeeze before elections. Experts said resolving the capital crisis and restarting government spending must be a priority before initiating further economic reforms.
Consumption typically picks up during elections, but it was muted this time. Therefore, restarting government spending partially holds key to reviving economic activity.
Analysts expect the new government to focus on reviving the business cycle, unclogging the financial system and building risk and investment appetite. “This is imperative since the investment cycle is stuck, asset quality is still a challenge, the funding cycle is mired in liquidity issues and consumption has been trending down. We believe the need to kick-start the economy is paramount—there should be fiscal and monetary stimuli," Edelweiss Securities said in a 23 May note to clients.
Public sector banks, still reeling under the burden of bad assets and mounting losses, would require capital infusion of up to ₹40,000 crore, according to estimates by credit rating companies. As in the last few years, the government is unlikely to pump in the entire requirement and would rather prefer banks raise some of it from the market to be on an even keel; to get them into lending mode would require another dose of capital.
Tapping equity markets is not going to be easy either. Twelve of the 18 state-owned banks that reported losses in the fourth quarter of FY19 have eroded their capital base, making it harder to raise money from capital markets. Alka Anbarasu, vice-president and senior credit officer at Moody’s Investors Service, said the rating firm expected capital requirement for state-run banks in the current year at ₹25,000-40,000 crore.
“This capital will help banks meet the regulatory capital requirements under Basel III and strengthen loan loss provisions, and thereby improve systemic stability of banks," said Anbarasu, adding that NBFCs and housing finance companies were well-capitalized; however, their ability to roll over maturing liability was a cause of concern.
Asit Bhatia, managing director of global corporate and investment banking at Bank of America Merrill Lynch, said: “We believe that RBI will ensure liquidity and help confidence return to the system. As an immediate measure, they would need to do a bit more of open market operations and forex swaps. The government needs to fuel growth by increasing public spending, which has been a bit muted in the last 6-12 months."
Analysts said around four public sector banks require capital to meet regulatory norms, while the rest would need it to expand lending. Moreover, as demand for credit picks up, banks would end up deploying capital at a faster rate than they can replenish. For every percentage point increase in credit growth, banks consume 10 basis points of total capital. Public sector banks posted an aggregate credit growth of 10.52% in FY19, shows Capitaline data.
Krishnan Sitaraman, senior director at rating agency Crisil Ltd, said that private banks were well-capitalized; their asset quality is relatively better and they were registering decent profits as well, which were getting added to their capital.
Some analysts expect the government will use RBI’s excess capital reserves to pump money into state-owned banks. Bank of America Merrill Lynch (BoFAML) expects the government to recapitalize state-owned banks with excess RBI economic capital of ₹1-3 trillion/$14-42 billion), set to be identified by the Jalan committee, by June.
“This should be liquidity-neutral and fiscal deficit-neutral. With the Modi government getting a renewed popular mandate it should be easier for the Jalan committee to hand over the excess RBI capital in one shot to the finance ministry," it said in a note on 24 May.
According to analysts at BoFAML, the other policy priority of the new government would be to lower lending rates.
At NBFCs, the liquidity crisis is severe. These lenders could not absorb the shock from defaults at Infrastructure Leasing and Financial Services Ltd (IL&FS) and the consequent shortage of money available to them. In addition, most NBFCs have borrowed short-term money to fund long-term assets; they were able to continually refinance their borrowings as long as liquidity conditions were easy. Once liquidity tightened, they ran into repayment challenges and the prospects of rating downgrades. Experts say that unless banks are recapitalized and assured of a solution to the NBFC crisis, they will remain reluctant to lend to the sector.
According to Crisil’s Sitaraman, until last September when IL&FS defaulted, NBFCs were having a smooth run as far as resource mobilization was concerned on the debt and equity sides, and many of them had got large amounts of equity capital. “There was equity interest in those companies and we saw NBFCs growing at a compound annual growth rate of 18% in the four and a half years or so prior to September 2018," he said.
After the IL&FS default, there have been worries about lending to the sector; these concerns were higher in October and November than at present, said Sitaraman.
Meanwhile, the capital market is expected to see several new listings on the exchanges.
M. Sriram contributed to this story