By Kriti Rathi
India’s banking sector is a study in contrasts. It supports the world’s fastest-growing large economy but is grappling with challenges that continually test its vigour and resilience. According to a prognosis by India’s central bank, these challenges will worsen before they start to improve. This prognosis was made in the central bank’s latest Financial Stability Report, which reported on the health of Indian banks, and was released on the 21st of December 2017.
Problems with capital at the banks
One-sixth of the loan books of public sector banks are already filled with bad loans. Even the condition of scheduled commercial banks is not great with, an increase in bad loans from 9.6% of gross advances in March 2017 to 10.2% in September 2017. And these are expectated to increase further in 2018.
Before banks can raise new capital they must recover their financial situation by putting into effect a new, more rigid law against bankruptcy. However, It remains to be seen how much of their credibility the banks can recover and how soon.
Ultimately, however, banks must raise more capital, partly to absorb the shock of their bad loans and partly to step up lending. So far, the banks have raised a record Rs 33,248 crore via qualified institutional placements (QIPs) and an additional Rs 40,000 crore is planned by the government in recapitalisation payments.
Finally, banks must increase the availability of credit. The increase in bad loans—also known as gross non-performing assets (GNPAs)—has reduced the ability of banks to lend, causing credit growth to fell for three consecutive years. Although there was an uptick in the growth of creadit in the six months leading up to September 2017, this was marginal.
The latest reforms are now taking effect
On Wednesday the 24th of January 2018, the government formally kicked off its banking reforms, with a capital infusion of Rs 88,000 into the ailing public sector banks in order to tackle their problem with bad debt. Lenders with high stressed-asset ratios, such as IDBI Bank, will get a bigger portion of the money.
Addressing a press conference, finance minister Arun Jaitley said that the need for banking reforms is independent of the government’s stated objective of encouraging consolidation in the banking sector. “We are setting up an institutional mechanism to ensure what has happened in the past is not repeated. It is the government’s responsibility to keep state-run banks in good health and ensure they follow the highest standards of corporate governance,” Jaitley said.
Under the new reforms, banks have been asked to link up with agencies which specialise in monitoring credit exposure above Rs 250 crore. The government has made clear to the banks that loans must be arranged with the utmost diligence . Banks must also ring-fence cash flows with the creation of separate stressed-asset management departments that will focus solely on the recovery of loans. Improving customer experience and making easy loans available for micro, small, and medium size enterprises (MSMEs) are also among the requirements.
Recapitalision payments are being made
Public sector banks will also be capitalised in the current fiscal year through a mixture of Rs 80,000 crore worth of recapitalisation bonds and the direct injection of Rs 8,139 crore. In addition, banks have raised more than Rs 10,000 crore so far on their own and will raise more in the coming months from the market, taking the total recapitalisation amount to over Rs 1 trillion for this fiscal year.
The recapitalisation bonds, which will be issued once the boards of the banks commit to the reforms will be issued for 10-15 years and will not impact the fiscal deficit this year, according to Subhash Chandra Garg, a secretary at the Department of Economic Affairs. However, is issued, these bonds would show up in the future liability of the union government. Nevertheless, this scheme is planned to be a cash-neutral and the bonds will be priced at the average three-month yield of the corresponding government security plus spread.
In tntroducing the plan for banking reforms, the government said that the banks should have a minimum of 10% exposure to big syndicate loans in orde to ensure greater stability. At present, small banks have very little exposure to such loans.
IDBI Bank Ltd and the Bank of India, which have been placed under prompt corrective action (PCA) by the Reserve Bank of India, will receive the highest capital infusion from the government at Rs 10,610 crore and Rs 9,232 crore, respectively. The PCA framework has been established by the government to fix the damage caused by bad loans and to help stabilise growth in the Indian banking sector. The State Bank of India and the Punjab National Bank, which are not under the PCA framework, will get Rs 8,800 crore and Rs 5,473 crore, respectively, as the government looks to support their growth while Indian Bank, a smaller but profitable state-run lender, was the only bank to have not been allocated any capital in the latest round.
Reaction to the government’s recapitalsation efforts
According to the banks, the new capital will help in backing growth and meeting regulatory requirements. R. Subramaniakumar, MD & CEO at Indian Overseas Bank said, in response to the government action, that “This capital will help us grow our loan book mainly in retail, agriculture and MSME sector, and meet regulatory capital requirements. Some amount will also go as provisioning for ageing of NPAs (non-performing assets). But that will be offset by the resolution we are expecting in the NCLT (National Company Law Tribunal) cases.”
But not all is positive, in a critical evaluation, Srikanth Vadlamani, vice president of the financial institutions group at Moody’s Investors Service, noted that the reforms the banks might undertake in order to receive the government funds may not be enough. “While some of these changes are steps in the right direction, we do not judge them to be meaningful enough to address the structural corporate governance issues facing these banks,” he said. Nevertheless, in the current situation the reforms are having a good impact on the condition of the banks, for example state-run bank shares rose ahead of the announcement, with the Nifty public sector bank index closing 3.5 percent higher.
Featured Image Source: Flickr
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