Capital Infusion In Indian State Banks Is Just A Band-Aid Solution

 Shares of India’s state-run banks have been rallying since 31 July when finance minister Arun Jaitley announced a Rs.70,000 crore capital infusion into this set of banks over four years. Going by the plan, Rs.25,000 crore will be infused in phases during the current fiscal year and an equal amount next year, and Rs.10,000 crore each over the following couple of years till 2019, when the new Basel norms kick in, which require banks to have higher capital to take care of market risks.

In the past 15 years, the Union government has infused more than Rs.81,000 crore capital in public sector banks and the bulk of the money has flown in between 2010 and 2014 even as banks started seeing an erosion in capital as they needed to set aside money for rising bad assets. In 2015, Rs.11,200 crore was allocated for the purpose, but the actual capital infusion was Rs.6,900 crore into nine public sectors banks, based on their performance. In the current fiscal year, the budgetary allocation was Rs.7,940 crore.

The decision to infuse such a large amount in state-owned banks, which roughly account for 70% assets of India’s Rs.92.5 trillion banking industry, is a signal that the government cares for them. Indeed, it is well aware of the issues that have been plaguing these banks—many of which came up for discussion at Gyan Sangam, a first-of-its-kind bankers’ retreat in Pune in the first week of January, attended by Prime Minister Narendra Modi—but there has hardly been any action. For instance, the top post in public sector banks has been split between the non-executive chairman and managing director, but no chairman has been appointed as yet. Some of the large banks today do not even have managing directors.

At least on the recapitalization issue, the government has walked the talk. This action has also debunked the theory doing the rounds among some foreign investors that the Indian government wants to marginalize the state-owned banking system and encourage private banks to play a larger role in Asia’s third largest economy. Now, the two key questions are: is this money enough to take care of the capital needs, and, if it is not, how easy or difficult will it be for the public sector banks to raise money from the markets.

A 2012 Reserve Bank of India estimate put the capital requirement at Rs.5 trillion till March 2019, including equity worth Rs.1.75 trillion. Banks need capital for two reasons: one, to support the credit need of the borrowers, and, two, to make good the erosion in capital as they need to set aside money to take care of bad assets. With a sharp drop in credit demand, the capital requirement is likely to come down. A September 2014 report of global rating agency Moody’s Investors Service says the 11 Indian public sector banks that it rates—which account for 62% of loan assets—could need up to $37 billion (around Rs.2.2 trillion) between 2015 and 2019, assuming a moderate recovery in economic growth and a gradual decline in bad loans. Jaitley, in his last year’s budget presentation, pegged the amount at Rs.2.4 trillion.

For quite a few public sector banks, bad loans account for close to one-fifth of their loan assets, and for some of the smaller banks, the core capital is less than 8% of their loan books at this point. Clearly, the state-run banks need more capital. Where would the money come from? From the market. Theoretically, it is possible as the government stake in all public sector banks is way above 52%, the threshold limit that Jaitley indicated in his February budget speech. The government’s stake is the lowest in Bank of Baroda at 57.53%. It is around 60% in four other banks, and around 80% or more in half-a-dozen state-owned banks. So, there is enough scope to divest the government stake and raise money from the public.

However, are investors excited about public sector bank stocks? It does not seem so. Barring State Bank of India and Bank of Baroda, all state-run banks are trading at a discount to their book value. Contrast this with some of the private banks such as Kotak Mahindra Bank Ltd, HDFC Bank Ltd and IndusInd Bank Ltd. They are trading at between three-and-a-half and five times their book value.

So, it will not be easy to sell public sector bank stocks in the market. Of course, Life Insurance Corporation of India (LIC), can always come to the rescue, but that’s not the right way to generate capital. For the record, LIC’s average holding in the banking sector is around 9%, and in at least 15 public sector banks it is more that 10% with the highest, a 22.54% stake, in Corporation Bank, and an around 15% stake in Bank of India and Canara Bank. One can always question LIC’s wisdom in making such large investments in public sector banks and wonder whether there is pressure from the government to make such investments, but that’s not relevant in this context.

Jaitley’s big-bang bank recapitalization announcement offers temporary relief to public sector banks, but it won’t lead to a re-rating of their stocks. If the rally is to be sustained, the government must address some of the fundamental issues and infuse right skills and expertise in these banks. In their absence, capital infusion alone is a band-aid solution to the problems.

Tamal Bandyopadhyay, consulting editor of Mint, is adviser to Bandhan Financial Services Pvt. Ltd, India’s newest bank in the making. He is also the author ofSahara: The Untold Story and A Bank for the Buck. Email your comments to [email protected]. His Twitter handle is @tamalbandyo  

This blog first appeared in www.livemint.com