Jaitely’s reluctance to fund banks is dangerous; weak lenders will derail India story

Finance minister Arun Jaitely, most likely, is on a collision path with the Reserve Bank of India (RBI). Time and again, the central bank has been reminding, cautioning and even warning Jaitely on the weak capital position of India’s public sector banks, which are heavily dependent upon the government with respect to their capital needs. But the government has so far either undermined the need to address this problem or simply doesn’t want to do it. Now, things have changed a bit. The central bank has now stepped up pressure on Jaitely to do what he needs to do. “We have been raising this issue (capitalisation of state-run banks) at various discussions and forums and it was also formally written by RBI," deputy governor S S Mundra said on Thursday. Mundra’s comments came ahead of Jaitely’s meeting with chiefs of state-run banks to assess their performance, today (Thursday). (Interestingly, even after the central bank’s move, Jaitley showed no inclination to address the grave issue at the press conference after the bankers’ meeting.) [caption id=“attachment_2292532” align=“alignleft” width=“380”] Public bank chiefs are meeting finance miniser Arun Jaitley today[/caption] This was bound to happen because, as Firstpost noted on the Union Budget day , Jaitely’s bank strategy has been built on weak premises. His handling of state-run banks has been all wrong right from the beginning, ever since he decided to abruptly slash the annual capital infusion to these entities. These banks are an important constituent in India’s Rs 95,00,000 crore banking industry. Jaitley was busy pondering ways to prop up growth in the economy, but unfortunately he forgot the most critical part - recapitalising the banks. This is a basic requirement in order to resume credit flow to projects, especially so in the absence of private investments and on account of the government’s own unwillingness to step up pubic spending. As against the originally announced capital infusion of Rs 11,200 crore, the government ultimately infused only Rs 6,990 crore in select banks in 2014-2015, based on the performance parameters (mainly going by the weighted average of return on assets (ROA) for public sector banks). For the current fiscal year, the budgeted capital infusion is about Rs 8,000 crore, where as the requirement is double. This is where the RBI has now intervened. “We have been suggesting to the finance ministry from time to time that the public sector banks need more capital than what budget has indicated,” Mundra said. The RBI wants the government to more than double the amount earmarked for banks. To be sure, there is some smart thinking in Jaitely’s rationale of cutting short the capital support. His argument is that state-run banks shouldn’t be entirely dependent on the government to raise capital. Instead, they should tap investors in the open market. Secondly, the creation of a Banks Board Bureau (BBB) is underway, which will advise strategies to banks to raise capital. But the counter-argument is that these are solutions for long-term and doesn’t address the problem at hand. The problems are broadly two: For one, the capital requirements on account of Basel-III norms and secondly, capital burden arising out of higher share of bad and restructured loans. Capital conundrum Public sector banks require about Rs 2.4 lakh crore to meet the advanced capital norms under Basel-III by 2019. While there is some certainty about this part, the real problem lies with the second issue – stressed assets, where even the central bank doesn’t seem to have a clear estimate of the actual impact. How do stressed assets result in higher capital burden for banks? Under norms, banks need to set aside money in the form of provisions on every rupee they lend. If the loan becomes non-performing, the provision requirement increases accordingly and up to equal amount of the money lent. The burden has doubled on the restructured loans as well from this April, banks are required to treat all fresh restructured loans as NPAs, which makes the provision shoot up to 15 percent for every fresh restructured loan. In the backdrop of a delayed economic recovery, the pain associated with stressed assets only rises. The RBI is well aware of this problem and, hence, rightly raised the issue. “That (addressing stressed asset problem) is the whole idea of increased capital. It can partly help to clean the balance sheet. Make the balance sheet ready to support when growth returns, additional capital will support the growth also," Mundra said. Addressing the bad loan pile is the biggest problem now the industry is facing. The gross NPAs of 39 listed banks have crossed Rs 3,00,000 crore as of end March, of which 90 percent is on the books of public banks. Restructured loans also have escalated in the recent years, now estimated around Rs 4-6 lakh crore. The slow economic activities on the ground means that a significant chunk of this can turn into bad loans. Capital is a necessity. Jaitely’s new found logic on performance-based reward of PSBs doesn’t hold much water since public sector banks have been under government control for all these years, religiously acting as vehicles of directed lending to high-risk sectors, besides rolling out government schemes. They need to be given full autonomy and a transition phase to adjust to the new reality, not on short-notice. For a capital constrained-government, there aren’t many options left at this stage. As Firstpost noted before , Jaitely can spare banks from dividend payments to offer some release. Certainly, Jaitely cannot escape the responsibility of funding the capital-starved banks until the time government continues to be the majority shareholder in them. But, the long-term solution is to show the courage for radical reforms. Eventually, the Narendra Modi government will have to get rid of its phobia on the P-word and practice what it has always preached. The government has no business to be in business. If banks do not have adequate capital, some of them can fail and any such failure will have massive repercussions in the financial system. Sooner or later, the government will have to exit its majority ownership in government banks and stop being in the business of banking, directly or indirectly, by privatising these entities. Such an exercise can free up lot of capital for banks and ensure efficiency in their operations through better autonomy. The process can begin with smaller banks and try with larger ones based on the experience. The question is: Does this government have the courage to embrace such a radical reform step? (Kishor Kadam contributed to this story)