Public sector banks must move beyond recapitalization bonds

When a human body suffers a grievous injury, it takes time to heal. In a similar vein, public sector banks (PSBs) suffered a grievous injury when they ended up with a huge amount of gross non-performing assets (NPAs) or bad loans, which peaked at ₹8.96 trillion in March 2018, or around 14.6% of total loans. Bad loans are largely loans which haven’t been repaid for a period of 90 days or more.

The PSBs have gone through a healing process. As of December 2021, their bad loans had fallen to ₹5.59 trillion, or around 7.9% of total loans. This happened primarily on account of bad loans being written off after four years, the recurrent recapitalization of PSBs by the government, the recovery of a few bad loans, and the banks being put through the prompt corrective action (PCA) framework by the Reserve Bank of India (RBI). Perhaps enthused by these factors, RBI Governor Shaktikanta Das recently asked these banks to strengthen their lending capacity (bit.ly/3EPehIJ) by raising capital.

Over the years, the bad loans of PSBs had to be written off against their accumulated capital. Hence, for these lenders to stay operative, the government as their major owner had to regularly invest fresh money in them. From 2010-11 to 2017-18, the Centre infused ₹1.12 trillion. This helped PSBs stay in operation despite their huge bad loans. The money for rescues came from the Union budget.

In October 2017, the government came up with the idea of issuing recapitalization bonds to put fresh money into PSBs. The way this magic wand worked was fairly simple. Let’s say a bank needed to be recapitalized to the extent of ₹2,000 crore. The government issued recapitalization bonds worth that amount, and the bank then used its deposits to buy these bonds. The Centre took that money and re-invested it back in the bank. This ensured two things. First, any bank which was running short on capital was adequately capitalized. Second, the government didn’t have to spend any money from its budget, at least not immediately. Of course, the government has to pay an annual interest on these bonds to PSBs. The interest amounts to anywhere between 6% and 8% a year.

Hence, by issuing these bonds, the government basically pushed back an expenditure that it should have made at a given point of time. In total, the Centre has issued recapitalization bonds worth ₹2.79 trillion so far. These bonds will mature from 2028 to 2036. When they mature, the money for repayment will have to come from that year’s budget. Hence, bank recapitalization bonds are similar to the oil bonds issued by previous governments to compensate oil marketing companies for their under-recoveries while selling petrol, diesel, domestic cooking gas and kerosene. In both cases, the government of the day postponed expenditure.

The good thing is that Governor Das has encouraged banks to raise capital from sources other than the government. It is worth remembering that the Centre needs to own at least 51% of the shares of a public sector bank at any point of time. If a PSB raises money from the stock market, this would automatically lead to some dilution of the government’s stake.

As of now, the government’s shareholding in many of these banks is high enough for that not to be a worry. The government owns around 73% of Punjab National Bank, 64% of Bank of Baroda and 80% of Indian Bank. The trouble is that the valuations of these banks, despite recent improvements, are very low in comparison with private banks. Hence, there isn’t much money they can raise by selling new shares on the stock market and letting the government’s stake decline to 51%, say.

In that sense, it is time to implement a recommendation that the Committee on Banking Sector Reforms of 1998 (the Second Narasimham Committee) had made. It had recommended that the minimum shareholding of the government in PSBs be brought down to 33%. Even at this level of ownership, along with holdings of Life Insurance Corp. of India and other state-owned entities, the government would continue to keep control as their major owner.

Doing this has become all the more important given that PSBs have constantly been losing market share to private banks since 2010. The only way they can stay in competition would be by lending more, and for that to happen, they need more capital.

As of March 2010, PSBs had given around three-fourths of all outstanding bank loans in the country. The share of private banks stood at 17.4%. As of December 2021, the share of PSBs was down to a little over 55%, with the share of private banks having risen to 36.5%.

What this means is that private banks are giving more newer loans. For the period of 12 months ending December 2021, private banks had given out 54.5% of all incremental loans. In comparison, state-owned lenders had given just 31.8% of incremental loans.

The point is that while individual PSBs are not being privatized, the general privatization of India’s banking sector has been on for more than a decade. If the government wants this to slow down, then it needs to come around to the idea of owning just 33% of their equity. Else, most of these banks won’t really matter in another decade or so.

Vivek Kaul is the author of ‘Bad Money’.