A change of stance on PSU banks | Business Standard Column

Until recent months, most policymakers seemed to be convinced that PSU banks (that is, majority government-owned banks) did not need to grow. They argued that there was abundant banking capacity: Bond markets were expanding, non-banking finance companies (NBFCs) and newly licensed small finance banks were driving innovations, and well-capitalised private sector banks were growing their loan books at more than 20 per cent a year, several times the system loan growth.
Further, slow growth in PSU banks has seen them lose share rapidly in recent quarters, in line with the government’s belief that privatisation of the banking system can be achieved with the least disruption and political risk if the experience of the telecom and airline sectors is repeated. The government never sold its stakes in BSNL or Air India, but the telecom and airline sectors respectively got privatised as these firms steadily ceded market share to private competitors. Thus, while the government stood firm on not letting any PSU bank fail, it refrained from making growth capital available to them.
However, recent commentary points to an acceptance of the utility of PSU banks in making available credit to SMEs (small and medium enterprises), particularly in smaller towns. And, that sick PSU banks could be adding to the economic slowdown by hindering access to capital for the most vulnerable enterprises, which are too small to tap the bond market, and unfamiliar so far to the new banks. The most recent quarterly statistics from the Reserve Bank of India (RBI) (June 2017) do not fully support this diagnosis: Rural and semi-urban credit grew at 12 per cent a year, faster than the banking system’s growth of 8 per cent. It is credit in metropolitan areas that is growing slowly, at less than 6 per cent. That said, there is merit in the argument that a system that accounts for nearly two-thirds of all lending would have knowledge of borrowers that would be hard to replicate quickly. In fact, PSU banks do have an above average share in offices reporting Rs 5 crore to Rs 100 crore loans.
Thus, the provision of growth capital is beginning to be debated.
In our view, even raising the recapitalisation amount from Rs 100 billion to Rs 250 billion (as per some media reports) would fall short by the proverbial mile: The recapitalisation to just plug the hole created by the second round of 40 cases that are likely to enter insolvency proceedings in December would need to be several times higher. As many of these loans (total Rs 3.5 trillion) have gone bad only recently, banks have not needed to book significant losses against them so far. But, once they enter insolvency, as per RBI guidelines, banks will have to take 50 per cent loss provisions. As most of the bad loans lie with PSU banks, this could create losses of more than Rs 1 trillion for them. Lastly, the transition to IFRS (International Financial Reporting Standards), which Indian banks are required to comply with starting 1 April 2018, is also likely to front-load loan losses for banks.
The government may be aware of the scale of recapitalisation needed: It appears to be considering tools like “recapitalisation bonds”, where the government injects equity capital into the PSU banks, and the banks in return buy government bonds. As the bond market is bypassed, it is hoped the impact on yields would be minimal. Further, under some accounting standards this recapitalisation would not add to the fiscal deficit (under Indian budgetary norms it would). As India’s banking system is relatively small in comparison to its gross domestic product (GDP), a 2-2.5 per cent of GDP worth of recapitalisation (say spread over two years) should not create solvency risks for the sovereign, and at the same time should repair and revive PSU banks.
But a bigger challenge for the government would be to address deeper issues that refuse to go away. Most of these banks are unable to generate the required economic returns even without the loan losses. How can the government ensure that the poor lending practices of the past that landed the banks in this predicament will not be repeated? What are the political risks if promoter groups in insolvent companies retain control with a significant write-down of debt, even as the government injects taxpayer capital into banks to write the debt off? Given the fiscal constraints, and the need to stimulate the economy, is this the best use of capital?
As we approach what appears to be the end-game for India’s bad-loans problem, and as the government realises the economic costs of letting PSU banks wither away, one wonders if a more drastic change of stance is warranted. Not letting this crisis go waste, the government could begin to set the discourse for privatising some of the PSU banks. That way their valuable branch networks and customer knowledge would be retained, and the deeper competitive issues would slowly be addressed. Given all the ongoing disruption due to structural changes in the economy, one more may not hurt that much.
The writer is the India Equity Strategist for Credit Suisse

via A change of stance on PSU banks | Business Standard Column

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