Govt cannot keep infusing capital perpetually
Public sector banks (PSBs) are reported to have written off about Rs 8 trillion worth of loans over the last seven years, which is more than twice the Rs 3.37 trillion capital infused by the government in the same period. Fiscal year 2018-19 witnessed the maximum write-offs at Rs 1.83 trillion. The last four years have been particularly bad for PSBs as they wrote off loans worth over Rs 1 trillion every year. This is clearly an unsustainable position, and the government cannot perpetually keep infusing large sums of capital into the banking system. It has been issuing recapitalisation bonds over the last few years because of budget constraints, but this medium also has limits.
The sorry state of PSBs, which account for the bulk of the assets in the Indian banking system, could have longer-term growth implications for the economy. Although the second wave of the pandemic has had a limited impact on banks, the gross non-performing assets (GNPAs) for PSBs are still expected to go up to 12.52 per cent by March 2022, according to the Reserve Bank of India (RBI). Since most PSBs command low valuations and are not in a position to raise capital from the market, the government would need to keep infusing funds at a time when it needs to increase public spending to support the economy battered by the pandemic. But not infusing capital will affect the flow of credit to the productive sectors of the economy, which will delay a full economic recovery.
Bad loans started rising during the early part of the last decade — a result of excessive lending, both before and after the global financial crisis. However, banks were not forthcoming in recognising stress. Thus, the RBI conducted an asset quality review during 2015-16, which led to a surge in bad loans. Predictably, PSBs accounted for a large chunk of the NPAs and the government had to infuse capital to sustain their operations. One of the big reasons for higher stress in PSBs is their inability to properly evaluate businesses and track progress. Further, bankers in the public sector are reluctant to recognise bad loans in time because of the fear of investigative agencies, which tends to worsen the problem. Most of these issues have been debated at length and the government has taken several steps to improve the functioning of state-run banks, but they don’t seem to have had any significant impact, largely because the nature and structure of PSBs have been left untouched.
The government has also put in place a bankruptcy law, which has strengthened the position of lenders though the recovery has been muted so far. Since it is clear that there are limits to the extent PSBs can be reformed and are likely to remain a drag on government finances, the government should speed up their privatisation. The government intends to privatise two PSBs in the current fiscal year and the NITI Aayog has reportedly made its recommendations. Immediate steps must be taken to take this forward and make way for privatising more banks in the coming years. This will not only help strengthen the banking system but also allow the government to stop throwing good money after bad.