Budget 2015: State-run banks desperately need capital; will FM get solution right?
Beyond the pacifying words on autonomy and support at the Gyan Sangam, Jaitley will have to bring himself some concrete roadmap in the budget
As the NDA government is busy preparing the contours of the Union Budget 2015-16, India’s capital-constrained state-run banks are pinning hopes on some solution from the government, their owner, which would enable them meet their increasing capital requirements.
“It would be critical for Jaitley to offer some concrete roadmap on capital infusion plans in the budget to put their concerns at rest as the problem seems to be bigger than one estimates,” said a senior official at a large Mumbai-based state-run bank, who requested anonymity.
That, precisely, will be one of the major challenges for finance minister Arun Jaitley and his team at the ministry. Would they be to solve the puzzle of capital conundrum of state-run banks, which are critical for India’s banking industry thanks to their sheer market share (over 70 percent until September) and interconnectedness with rest of the financial system?
Public banks are indeed staring at a massive cash crunch in the years to come on account of three reasons.
One, they would need a substantial amount of capital to meet the mandatory capital requirements under the Basel-III norms. Two, these banks will have to make provisions for a sizeable chunk of stressed assets on their books (about 14 percent of the total loans given roughly). Third, they need capital support if the want to grow their loan books competing with existing and incoming rivals.
The numbers are huge. Here are some commonly agreed estimates. The estimated equity capital requirement for state-run banks to meet the Basel-III norms alone is about Rs 2.4 lakh crore.
Basel-III is the advanced capital norms all banks worldwide need to comply with in a phased manner. For Indian banks, the deadline is 2019.
With the deadline to meet the advanced capital requirements under the Basel III norms fast approaching, sate-run banks will need to raise substantial amount of capital.
Global ratings agency Moody’s Investors Service estimates the state-run banks would need anything between Rs 1.5 lakh crore and Rs 2.2 lakh crore, or $26 billion and $37 billion, to comply with Basel-III. This estimate covers just 11 state-run banks that the agency rates. These are estimates and the actual requirement could vary, likely on the upside.
As per the Basel-III norms, banks need to have minimum equity capital adequacy ratio of 7 percent and Common Equity Tier-1 (CET-1) capital of 5.5 percent. A Firstpost analysis of Capitaline data shows that at least five government banks have Tier-I capital adequacy less than 8 percent.
In addition, banks will also need to build a 2.5 percent capital conservation buffer to be used in bad times.
Basel-III requirement is only one side of the story. The other side is the stressed asset scenario, which could emerge as a major risk for state-run banks. At present, the stated amount of bad loans in the banking system is Rs 2.7 lakh crore, while the restructured loans are estimated to be between Rs 5 lakh crore and Rs 6 lakh crore.
According to the PJ Nayak committee, which looked at various aspects of public sector banks, state-run banks would need over Rs 3 lakh crore capital if their loan book grows 16 percent per year and if about one-third of their restructured loan portfolio turns bad.
As Firstpost noted earlier, the real risk is that not all bad loans are correctly reflected on the books of state-run banks. Many are hidden in the form of restructured advances. Admitting bad loans to restructured pile and thus keeping them standard, is a temporary rescue operation done by banks based on the idea of mutual convenience.
For the borrower, this helps to avoid the tag of a defaulter and banks can show lesser bad loans on the balance sheet. It is difficult to estimate how much of the actual bad loans are hidden this way, but banks’ reluctance to acknowledge the base problem paves way to a risky future of unknown risk and the resultant capital requirements.
Third, even though the loan demand is yet to pick up and most banks are still struggling to hit double-digit loan growth, once the economy is back on track of higher growth, the demand scenario will change, necessitating banks to keep sufficient money ready to meet the loan demand.
That being the case, the government has no choice but to do what it apparently doesn't want to -- to let go off its supremacy in the running of state-run banks by reducing the holding in these entities.
If one takes a broad range, the government holds stakes ranging from 56 percent to 84 percent in 27 state-run banks. To be precise, the government has more than 70 percent stake in 12 state-run banks and over 80 percent in six.
Late last year, the NDA government had recently approved a plan to raise about Rs 1.6 lakh crore ($25.76 billion) by selling some of its stakes in state-run banks by 2019, by bringing down the holding to a minimum 52 percent.
This is the stated plan. The government wants state-run banks to go to the market and raise capital tapping the retail investor base, keeping the minimum government holding at 52 percent. The question is will this exercise suffice to resolve the problem? Mostly likely it won’t. The process, utmost, will give only a temporary breather to state-run banks given their massive capital requirements.
It would make immense sense for Narendra Modi and Jaitley to pay attention to the Reserve Bank of India (RBI) to understand the magnitude of the problem. The RBI has already cautioned that even if the government reduces its stake in state-run banks to 52 percent, that wouldn’t be sufficient enough to take care of their capital requirements.
"Recently, it has been reported that the government is contemplating scaling down their holdings in public sector banks to 52%. This may not be sufficient to fully meet the capital needs of the public sector banks under Basel III norms particularly since the projections are based on minimum requirements," R Gandhi, one of the deputy governors at the RBI said early this month speaking at a function in Kolkata.
Tapping markets, as Jaitley wants government banks to do to meet their fund requirements, wouldn’t be an easy task for most of the state-run banks, which have their valuations and balance sheets under pressure on account of immense stress on their books. The helping hand must come from the government.
What amount Jaitley will set aside for public banks in the budget is yet to be seen, but that sum is unlikely to offer any major relief for lenders. Remember, in the last four financial years, the government has managed to infuse a total of Rs 58,600 crore of capital in state-run banks. The budgeted capital infusion in 2014-15 is Rs 11,200 crore, just about half of what state-run banks actually need. What Jaitley plans in the upcoming budget for state-run banks is a mystery.
Clearly, Jaitely will have to do a lot of home work before announcing the plan for state-run banks as most of the rating agencies are eagerly looking at the government steps to resolve the capital conundrum in public banks. An inadequate response from the government could prompt the assessors to give a thumbs down to these entities.
In short, the currently estimated capital requirements for public sector banks can change drastically and the government might not be in a position to continuously feed these lenders given the fiscal constraints.
The permanent solution for the ‘capital’ problem of sarkari banks, as the P J Nayak committee suggested, is to privatise these banks by bringing down government stake below 51 percent and letting these entities operate as private entities. The government can ensure that shareholding of these banks is distributed widespread among the retail investors so that no single private investor can call the shots in their operations.
Beyond the pacifying words on autonomy and support at the Gyan Sangam, Jaitley will have to bring himself some concrete roadmap in the budget on what government plans to do with its stake in state-run banks and how it intends to feed these fund-starved entities.
For sure, the problem has grown as too big for Jaitley to ignore.
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