The finance ministry and RBI should quickly lay down guidelines for banks to issue bonus shares, and also raise the FII limit to 30% for investment in PSBs, which will not only be another dose of reforms, but greatly assist the PSBs in raising fresh capital from the market

The Parliament, in its last session, passed the Banking Laws (Amendment) Act, 2012, which allows nationalised banks to issue bonus shares. However, in the absence of clear-cut guidelines either from the finance ministry or Reserve Bank of India (RBI), public sector banks (PSBs) have refrained from issuing bonus shares to its stakeholders.

The ministry and RBI should also raise the financial institutional investment (FII) limit in PSBs to 30% from 20% currently, which would help banks to raise fresh, additional capital to meet the Basel III norms.

Background of government ownership of banks:

State Bank of India (SBI) was set up on 1 July 1955 by an Act of Parliament, namely State Bank of India Act, 1955, by which SBI took over the former Imperial Bank of India. In 1960, seven former state associated banks became SBI’s subsidiaries and thus eight banks were under the banner of the SBI group. Of these seven subsidiaries, two banks, namely State Bank of Indore and State Bank of Hyderabad, were recently merged with SBI, and as of now there are only six banks, including five subsidiaries, functioning under the SBI group.

The next wave of nationalisation took place in July 1969, when the country’s 14 top private banks were nationalised. Six more banks were nationalised in April 1980. Out of these six, New Bank of India was merged with Punjab National Bank in 1993, leaving only 19 nationalised banks functioning as PSBs, where majority ownership rests with the central government. There is one more bank under public ownership, namely IDBI Bank, which started as Industrial Development Bank of India. IDBI Bank bean as a fully government owned term-lending institution, but was converted into a full-fledged commercial bank and re-christened IDBI Bank. In short, there are now 26 PSBs controlling more than 70% of the total banking business in the country.

Listing of public sector banks in the stock exchanges:

SBI was the first PSB to tap the stock market in December 1993, when it offered equity to the general public. Subsequently, all PSBs, barring two subsidiaries of SBI, came out with public issues and offered shares to the public over the past 10 years. Consequent to the public offering, these 24 PSBs are listed on stock exchanges.

But these PSBs have not been favoured by investors for various reasons. All of them except SBI are quoted in single-digit price earning multiples on the stock market. Though they are considered strong banks, as majority ownership rests with the central government, their valuations are low in the bourses as is the case with most PSBs. This is because these banks, since their nationalisation, have not rewarded the shareholders, except with annual dividends at pay out ratios, prescribed by the RBI. As these banks do not come under the Companies Act, 1956, they were not able to issue bonus shares as per the said Act. Though all these banks have substantial reserves in their balance sheets, there was no provision to issue bonus shares in the enactments through which they were nationalised.

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Amendments affected to their Acts to provide for bonus shares:

The State Bank of India (Amendment) Act, 2010, passed in 2010, provided for SBI to issue bonus shares, and the recent enactment, The Banking Laws (Amendment) Act, 2012, passed in the last session of Parliament has provided for issue of bonus shares by the nationalised banks. Now that the decks have been cleared by these Acts, we can certainly expect these PSBs to consider issuing bonus shares as this will provide a boost to their market image and will help them to raise additional capital required to meet the regulatory norms under Basel III over the next couple of years.

Why issue bonus shares?

Issuing bonus shares does not in any way improve the financial position of a company, as there will not be any inflow of cash into the coffers of the company. But it helps improve the image of the company, as giving free shares is considered a reward to shareholders. The stock markets always welcome the issue of bonus shares as it is considered an investor-friendly measure, which will help the company raise fresh equity through the capital market in due course.

The issue of bonus shares is a way to provide a larger number of shares to the market as the free-float in the market increases in the same ratio as the issue of bonus shares. Besides, the prices come down proportionately. Hence, these shares might appear affordable and attract the attention of small investors, thereby widening the investor base of the company. Besides, the issue of bonus shares is an indication that the management is confident of servicing a larger capital arising out of the bonus issue. However, there is no obligation on the part of the company to pay the same percentage of dividend on the increased capital.

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Guidelines for issue of bonus shares:

While Securities & Exchange Board of India (SEBI) has issued detailed guidelines for issue of bonus shares by listed companies, the most important one is that which specifies that the bonus shares shall be issued only out of free reserves built out of genuine profits, or share premium collected in cash only. The reserves created by revaluation of fixed assets should not be used for this purpose. There are a number of other conditions stipulated by SEBI, which are in the interest of the shareholders and must be complied with before bonus shares are issued.

However, the Department of Public Enterprises (DPE) of the ministry of heavy industries & public enterprises of the Government of India has its own guidelines for issue of bonus shares by public sector undertakings (PSUs; except public sector banks). This department of the central government has been guiding the PSUs under its control to capitalise their reserves and issue bonus shares. This is because the biggest beneficiary of such an issue will be the central government, by virtue of its majority holding in all these companies.

One criteria specified by the DPE is that PSUs with reserves in excess of three times their paid-up capital should consider issuing bonus shares to shareholders. And in deference to these instructions, most PSUs (except banks, which come under the control of the finance ministry) have issued bonus shares in various ratios over the past five years. Even as late as 25 November 2011, the DPE reiterated these instructions, as it felt that “holding huge reserves does not reflect equitable capital base of the company, and these companies declare dividend on a lower capital base”.

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Details of free reserves held by PSBs as on 31 March 2012:

All the public sector banks have large reserves and are comfortably placed to issue bonus shares, though the level of reserves vary depending upon their past performance on the profitability front.  The following table shows the extent of free reserves held by the 24 listed PSBs. The free reserves are clearly in excess of three times their paid up capital, the level stipulated by the central government for PSUs.
 

Most of these banks have improved their performance on the profitability front over the years through better management of their assets and liabilities. However, the RBI is concerned about the growing non-performing assets of these banks. It is a deterrent for issuing bonus shares liberally in the context of uncertain economic conditions prevailing in our country at present.

Increase FII investment limit from 20% to 30% in PSBs:

However, there is a dire need to create an investor-friendly image for PSBs and thus, improve their valuations on the bourses to enable these banks raise additional capital from the market to meet their capital adequacy requirements under Basel III norms. To achieve this, PSBs should not only be allowed to issue bonus shares, but the present cap of 20% for investment by FIIs in PSBs should be proportionately increased to at least 30%, in tune with the recent increase in the voting rights to 10%.

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(The author is a banking professional writing for Moneylife under the pen name ‘Gurpur’)