The Economic Survey talks of how the long-standing “exit” problem for companies has been addressed, but asserts this must be accompanied by reforms to shrink unviable banks and allow for greater private participation. It has hit the nail on the head. The government can’t forever be supporting weak state-owned banks; that would mean endless amounts of capital infusion. Instead, as the Survey recommends, it must find a way to “shrink” them taking care, of course, to protect depositors’ money. That is a tall ask at any time in India and particularly so in a pre-election year; the government is unlikely to be able to convince the trade unions of the benefits of such a move. Which is why it was not surprising the first tranche of capital infusion, announced last week for an amount of Rs 88,000 crore, was skewed towards weaker lenders with a large allocation of around 60%. These 11 banks—put under the Prompt Corrective Action (PCA) framework by RBI—contribute about 27% of the risk-weighted assets of PSU banks, but nearly 41% of the total gross non-performing loans. The infusion should boost the capital adequacy of banks such as IDBI Bank, Dena Bank or United Bank, allowing them to make more provisions for bad loans and clean up the balance sheet. Moreover, it should help them come out of the PCA framework and free them of several restrictions such as lending to borrowers below a certain grade.
If the idea is to resuscitate the banks for a temporary period and subsequently find a way to close them down, the money would have been well spent. The good news is the recap announcement did not hint at any merger or consolidation because that would only hurt stronger banks. It will be very difficult for many of the smaller weaker lenders to bounce back to a level where they can compete effectively in the market. This is especially so if the government expects them to lend to the MSME and agri sectors where bad loans will once again hurt their balance sheets.
At some point, therefore, the government must have a plan by which weaker banks are shut down. Private sector banks would surely be willing to pick up the assets and customers. Some of them may even be willing to take on the employees as long as they can cherry-pick the people. The point is that a one-time recapitalisation of Rs 1.3 lakh crore cannot resuscitate all the weak banks. Moreover, even if recap bonds are not part of fiscal deficit—only the coupon is—it is, as the Survey notes, part of the measured deficit.