Public sector banking crisis: Why recapitalising PSBs is akin to throwing good money after bad – The Financial Express–02.10.2017

B Mahapatra

The state of affairs at public sector banks (PSBs) is known to everyone by now. The current stress in their balance sheets has considerably eroded their capital and has incapacitated them for further lending, apart from the usual fear of three “C”s (CBI, CVC and CAG). What should be done now? The easy answer that comes to everyone’s mind is “recapitalisation”. There are several proposals floating around for recapitalising PSBs. The first and foremost is injection of capital by the government of India, the majority owner of these banks and statutorily required to maintain at least 51% equity capital in these banks. Publicly, the government is committed to provide adequate capital to PSBs for their survival and growth, and maintain Basel III capital standards, thereby aiding the growth of the economy. However, the government is constrained by its fiscal deficit. In 2015, it promised under the Indradhanush programme to inject Rs 70,000 crore into PSBs over 2015-19.

So far, it has injected about Rs 48,000 crore, and budgeted for Rs 10,000 crore for the current financial year and plans for another Rs 10,000 crore in the next. The government probably will not be able to inject more capital into PSBs given its own fiscal constraints. Under the Indradhanush programme, PSBs were required to mobilise capital of Rs 1,10,000 crore of their own from the market. However, PSBs (except SBI) have failed miserably in this regard, and probably have raised about Rs 3,000 crore only. One can appreciate that PSBs are scary about lending because of the three “C”s mentioned earlier, but why are they not been able to raise capital from the market, particularly when the stock markets are booming, with Nifty 50 surpassing the 10,000 mark? The answer lies in lack of appetite by the market to lap up PSB shares.

Most of PSBs’ existing shares are trading at a huge discount or a little higher than the book value, where their private sector peers are trading at a range about 2-7 times the book. PSBs feel probably this is not the “best” time to enter the market, and sell “family silver” at throwaway prices! One does not know when the good times will come for PSBs—probably after the clean-up of their balance sheets from the NPA mess.

Therefore, PSBs’ dependence on governmental budgetary support will only increase, which the government may not able to fulfil due to fiscal constraints. If the only source of capital is the government, it must try innovative ways to recapitalise PSBs. One such way is perhaps recapitalisation bonds. The government of India tried this method during mid-1990s. However, even if transactions were cash-neutral, and the government was funding the interest cost on the bonds from the budget, it did not pass the muster of international watch dogs for not being included as part of fiscal deficit. This is an opaque way to recapitalise PSBs and probably the government may not tread the same path again.

If the government cannot inject capital from its budget into PSBs because of fiscal deficit constraints, how about a PSB holding company, set up by the government, injecting capital into PSBs? If the government puts equity into the holding company, which, in turn, injects equity capital into PSBs, there is no added advantage as the government will face the same fiscal deficit constraint while injecting equity into the holding company. The logic here is perhaps the holding company will borrow from the market and inject the borrowed money as capital in PSBs.

If the borrowings by the holding company require the government guarantee to keep interest rate low on such borrowings, again the government may hit with FRBM limit of guarantees not exceeding 0.5% of GDP. The PSB holding company is like a bank holding company. From prudential regulation point of view, capital adequacy is seen not only at solo bank level, but also at consolidated bank holding company level. The very fact that the PSB holding company will hold majority shareholding at PSBs, capital adequacy will be seen at the consolidated holding company level also.

In a simple arithmetic line-by-line consolidation, if all PSBs are adequately capitalised, the holding company is also likely to be adequately capitalised. This is true so long as the holding company down streams the equity capital received by it from the government to PSBs. But if the holding company raises debts (bonds) on its balance sheet and down streams that as equity capital at the level of PSBs, even though PSBs will look well or adequately capitalised, the holding company will run short of capital as debt (bonds) issued by it will not be treated as equity capital in its books.

Another issue is from accounting consolidation point of view. Cross-holding of capital instruments among PSBs will be nullified at the holding company level, resulting in capital shortage at the holding company. There is already some cross-holding of tier-2 bonds among banks in general and PSBs in particular. Other issues that might emanate from this structure is how many times the holding company can leverage itself. As a holding company, it will be treated as a core investment company (CIC) by RBI and will have to follow CIC norms, which stipulates a leverage of 2.5 times. Above all, the holding company structure will require amendment to Bank Nationalisation Acts and SBI Act.

If it is not possible to inject equity capital, PSBs may think of obtaining from other investors as much Additional Tier-1 capital as possible under Basel norms. This form of capital is available, but at a higher cost, because of risk-absorbing features built into these instruments. PSBs can also maximise their limit of tier-2 capital, including subordinated debt.

PSBs are taking steps to partly or fully offload their investments in subsidiaries and associates so that these investments are not deducted from their capital for regulatory purposes. Some PSBs are also restructuring their business models to reduce risk-weighted assets requiring higher capital. RBI has amended its instructions to remove some of the provisions that were more stringent than Basel III norms, such as treating revaluation reserves, foreign currency translation reserves, etc, as tier-2 capital instead of tier-1. The government is also trying to improve corporate governance at PSBs in line with the recommendations of the PJ Nayak Committee. The government is also taking steps for consolidation of PSBs.

All these efforts are like drops in the ocean. Consolidation of PSBs will not solve capital shortage. Time is not opportune for consolidation, and can wait till the stressed asset problem of PSBs is resolved, otherwise it would divert attention of PSB management. There are different estimates of capital requirement by PSBs till 2019, depending on the normal requirement and hair-cut PSBs would take in resolving their stressed assets. The capital requirement of PSBs will only grow over time.

Once the NPA stress in their balance sheets is hopefully resolved, the stress of capital shortage will impede their growth. PSBs did not glow under the Indradhanush. If the government is not able to recapitalise PSBs to the fullest extent, it should look into alternative methods. Instead of throwing good money after bad, what is a better alternative than to privatise them?

The timing of privatisation is of essence, if not for political reasons then from the economic point of view of salvaging some value left with PSBs—unlike the case of Air India—before it gets too late.

Author is former executive director, RBI

via Public sector banking crisis: Why recapitalising PSBs is akin to throwing good money after bad – The Financial Express

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