The ministry of finance has announced as new scheme to capitalise public sector banks, which were reeling under the under the weight of bad loans and corruption. Under the scheme, the government will pump in only Rs18,000 crore of equity into public sector banks (PSBs), over the next two years. The banks will have to raise Rs58,000 crore from the market. Finally, the government will issue bonds worth Rs135,000 crore which the banks will buy. It is not clear whether the government will put back the money from bond sales as equity into banks and if yes, when with that happen. What the pros and cons of this move?
The most popularly shared benefit of the scheme is this. Banks will get more capital to lend. It is being argued that the economy is in a downturn because the PSBs are not able to lend. They need capital support. With more capital, PSBs will be able to write off the bad loans (which they have been unwilling to do for fear of eroding their capital) and still be able to lend more. The scheme enables the government to inject capital without budgetary support and impact on fiscal deficit. Once the banks start breathing easy, the government can also push for bank mergers. One other benefit, probably in the distant future, is that the government can get the upside from equity returns once the “recovery cycle” starts.
There are too many cons, in our view.
1. Too Little: This money is not enough according to analysts. After all, the bad loans were an astounding Rs7.33 lakh crore in June 2017. By some other estimates, the figure is close to Rs10 lakh crore. Of the package, Rs18,000 crore has already been allocated under the Indradhanush scheme.
2. Tiny Amount of Fresh Capital: While the scheme will encourage some amount of lending, it is not clear whether the government will promptly reinvest the money from bonds into the banks and in what form. If the capital injection by the government is too little, too late, banks would be worse off, after being drained of the liquidity. Even if the capital injection happens, the banks do not get any fresh capital (except the Rs58,000 crore they will raise from the market).
3. Low Borrowers’ Appetite: It is not clear, given the systemic shocks unleashed by demonetisation, the shoddy implementation of Goods and Services Tax and lack of any improvement in ease of doing business, what kind of risk appetite is there among businesses to borrow more at this time. Remember, apart from loans, many cash-strapped businesses need equity capital as well.
4. Redemption Unclear: The government has not clarified how the Rs1.35 lakh crore bonds will be redeemed. Can the banks sell these bonds? Will the bonds be marketable in any other manner?
5. No Governance Strings: The scheme does not make the PSB boards and top management accountable in any form. PSBs are in the current position because of rampant corruption. The Modi government has been attempting to fix PSBs through several half-hearted moves over the past three years. It seems to have ultimately given up on that that tough but the right path to fix the mess of PSBs.
All the move really does is to boost the flagging credibility of the government in taking “bold steps” to fix the banking mess. Expectedly, ratings agencies have hailed the move. But it will merely reduce the near-term risks facing the banks. To think that this would kickstart growth and investment cycle is far-fetched. Finally, a recapitalisation process that has failed in the past, allows crony capitalists to get away with wilful default and does nothing to solve the problem of corrupt and careless lending practices that is the root of the problem.