Indian markets cheer government’s cash support for its ailing banks

• Yesterday, India’s finance ministry approved a plan to pump ₹482.4 billion into 12 public sector (PSU) banks.
  
• Rather than dipping into its own pockets, the government will raise funds for the initiative from the markets through “recapitalisation bonds”.
  
• The move is linked to helping these state-owned banks, which comprise a lion’s share of the banking sector’s non-performing loans, avoid or exit the Reserve Bank of India’s Prompt Corrective Action (PCA) framework.
  

The great bank recapitalisation continues.

Yesterday, India’s finance ministry approved a plan to pump ₹482.4 billion into 12 public sector (PSU) banks. The Nifty PSU Bank index opened up over a percent in trade, defying an otherwise flat market.

The move brings the government within a hair’s length of it’s ₹1.06 trillion recapitalisation target for the financial year - which exceeds budget estimates by ₹400 billion. The balance ₹50 billion will go to Bank of Baroda, which is the process of a three-way merger with two smaller banks.

Rather than dipping into its own pockets, the government will raise funds for the initiative from the markets through “recapitalisation bonds”. This will likely be facilitated through a holding company so the debt doesn’t add to the government’s fiscal deficit.

The capital is squarely linked to helping these state-owned banks, which comprise a lion’s share of the banking sector’s non-performing loans, avoid or exit the Reserve Bank of India’s Prompt Corrective Action (PCA) framework, which imposes lending limits and curbs on hiring and expansion. If they aren’t on this watchlist, they can lend freely to small businesses and stimulate economic activity in a crucial election year.

Two struggling lenders - Allahabad Bank and Corporation Bank - will receive nearly ₹160 billion, or a third of the funds. This will help them exit the PCA framework, enabling them to restart lending operations.

The lenders will join fellow state-owned banks Bank of Maharashtra, Oriental Bank of Commerce and Bank of India - all of which were taken off the PCA watchlist on January 31st at the behest of the government. This was largely done with the government’s assurance that it would pump in funds when required, like an ATM.

Over 40% of the funding amount, or ₹197 billion, will go towards preventing four banks - Punjab National Bank, Union Bank, Syndicate Bank and Andhra Bank - from entering the PCA framework by ensuring their capital buffers and risk ratios don’t fall below a minimum threshold and enable two lenders who just exited the PCA - Bank of India and Bank of Maharashtra - to stay out of it.

Finally, four public sector banks on the watchlist - Central Bank, United Bank, UCO Bank and Indian Overseas Bank – have been given the remaining ₹125 billion to help them meet minimum regulatory norms.

However, if the bad loans at these banks continue to mount, they will only require further rounds of recapitalisation, something that the finance ministry is aware of. In addition to the recapitalisation announcement, the finance ministry said that it expected recoveries of ₹800 billion for the country’s banks before the end of the current financial year in March.

The ministry explained that some resolutions under the insolvency code were in their final stage, especially that of Essar Steel, which would result in a recovery of ₹520 billion. However, the prediction seems overly optimistic.

For example, the resolution of Essar, the bidding for which commenced more than a year, ago has been mired in judicial proceedings as ArcelorMittal butts heads with the former owners of the steelmaker over the resolution plan. An agreement doesn’t look likely within the next 40 days.

Furthermore, the banks are on the PCA watchlist for the reason that they can slowly be revived back to financial health. Taking them off the framework too early or capitalising them without the requisite governance changes only risks putting good money after bad and accelerating their short-term recovery at the cost of their long-term stability.

Finally, the funding amount won’t be enough. In a report released at the end of January, the State Bank of India said that public sector banks would require a further ₹500 billion worth of recapitalisation funds to meet credit growth targets.


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