EDITORIALNO .

SOURCE:-

A bold step in bank reform

TOPIC :-

What makes expert write on this topic ?

 It’s been late coming, but the recapitalisation of

public sector banks is a winner
REASON IS :-

Letsgo backtosomebasicsfirst

 RBI's deputy governor has suggested a ‘Sudarshan

Chakra’ solution for PSU banks, in the place of the
earlier 'Indradhanush' plan.

 It envisages a comprehensive plan which is more

focussed and targeted than the 'Indradhanush' plan.
What is the proposed new
reform?  It considers four “R”s which are envisioned as key to
solving the problems of the banks.

 They are:

 Recognition.

 Resolution.

 Recapitalization.

 Reform.
 Now , lets go back to editorial

Let us understand all these

terms in detail :

Recognition –
1. The RBI’s asset quality review has made a considerable progress in this regard.

2. It has revealed the numbers on gross non-performing asset (NPA) in general apart
from those in the PSU alone to be 12%.

3. However, this does not show the true picture as it does not include assets that are
“stressed” but not yet NPAs.

4. The market assessment is that when these stressed assets take the form of NPAs,
the NPA percentage may increase by up to 6%.

5. Thus, identifying the right proportion of the stressed assets is the first step to
resolving them.

Resolution –

1. The Insolvency and Bankruptcy Code (IBC) is a major reform in appropriately

addressing the bad loans problem.

2. The process under IBC will certainly clean up the books of the banks over the
coming months.

3. Nevertheless, the challenge is to find new investors who are willing to take over
defaulted projects.

4. The banks will have to face huge losses so as to attract new investors and this is
sure to have an impact with a corresponding erosion of capital.

Recapitalization –
1. In 2015, the finance ministry had estimated that the PSU banks needed Rs.2.4 trillion
of capital from market, retained profits and the budget.

2. The Fitch Ratings estimate the need to be Rs.4 trillion by end of March 2019, to
meet the capital requirements under Basel III.

3. The finance ministry is thus under huge challenge given the mounting NPAs along
with pressures for fiscal stimulus to counter the current slowdown.

4. Keeping on stimulating the economy through increased government expenditure and

draining out public funds is not a sound fiscal measure.

5. Perhaps, weak banks that have eroded their capital substantially could be subjected
to RBI’s “prompt corrective action” discipline.

6. This can limit new commercial lending until their capital position improves.

7. On the other hand, the healthier banks and non-bank financial companies, both
private and public, can expand and occupy the lending space created.

Reforms –

1. Reforms in PSU banks are essential to make them more efficient, and this is needed
irrespective of whether or not to recapitalize them.

2. Merging public sector banks cannot be considered a reform to address the problems
at present.

3. Instead, there is a need for reforms that improve governance, upgrade the skill set,
and improve the quality of risk assessment within the PSU banks.

4. Government should think of reducing its equity to 33% in selected PSU banks, as
recommended by Narasimham II Committee in 1998.

5. The government could still have a controlling position in the board, but the banks
could become board-managed companies.

6. This would allow the stronger PSU banks to raise additional capital from the market,
possibly from strategic investors who are offered seats on the board.

7. Inclusion of strategic investor may make it easier to raise capital without burdening
the budget.

8. In all, the scale of the bad loans problem is much larger than was thought and the
downturn in the economy necessitates more urgent corrective measures.
  It is expected that the exercise will be modelled on the
lines of a similar bailout in the nineties.

 That is the Centre issues recapitalisation bonds to

PSBs, and re-routes the sums so raised as equity
capital.

 The package envisages an infusion of Rs.1.35 lakh

crore through recapitalisation bonds and market
funding of Rs.58, 000 crore, aside from Rs.18, 000
crore from the Budget.

 These bonds after taking into account the existing

provisioning and the recoverable value of the
underlying loans will ensure a healthy capital base for
What is the planning of the PSBs.
government in this regard ?
 It is likely that the recap bonds will be placed with the
banks for which the government will get an equivalent
holding of equity in the banks.

 This will be a capital transaction because it not only

increases the government’s liability but also increases
its assets.

 The overall or net financial position of the government

remains unchanged.

 The issuing agency of the recap bonds, borrowing

costs and the identity of the banks who receive
infusion will all be keenly watched.

 When loans go bad and turn into non-performing assets

(NPAs), banks have to make provisions for potential
losses

 This tends to erode bank capital and put the brakes on

loan growth
How Bank capital affects
loan growth?  That is precisely the situation PSBs have been facing
since 2012-13

 Stressed advances’ (which represent non-

performing loans as well as restructured loans)
have risen from a little over 10% in 2012-13 to
15% in 2016-17
What is the Level of
stressed advances in the
PSBs  This has caused capital adequacy at PSBs to fall

 Average capital at PSBs has fallen from over 13%

in 2011-12 to 12.2% in 2016-17

 The minimum capital required is 10.5%

 Inadequate capital at PSBs has taken its toll on

the flow of credit

 Growth in credit has fallen below double digits

over the last three years
  Recapitalisation bonds were sold in 1990s to recapitalise
banks.

 The government issued these bonds to the nationalised

banks which subscribed them in the normal course of
their business.

 The capital thus raised was used by the government to

infuse fresh 'equity' into the cash starved banks.

 The idea is to borrow from the banks themselves and

boost the weaker banks’ capital, without an immediate
demand for direct government budgetary support.

 Globally, the practice is to not include bonds in the fiscal

Recapitalisation bonds deficit calculation. But in India, it is included as part of
the deficit.

 The effect on the fiscal deficit will thus depend on the

nature of the bonds and also how they are dealt with.

What are the Challenges ahead ?

 The challenge will be to ensure that the improper

lending to influential industrial groups that took
place on both sides of the global financial crisis
is not repeated

Point No. 1
 Giving banks extra capital was only one of the
seven grand themes of the Indradhanush
programme announced in 2015

 The reform of the Indian banking sector—and

especially the privatization of banks—should be
the next step

 Banks will not take adequate precautions when

they are lending when they know that the
government will step in to help if the loans turn
sour

 The government should be selective about which

banks get the additional capital on offer

Point No. 2  A statement by RBI governor suggests that the

banks which have worked harder to deal with
their problem loans will get priority in access to
fresh capital

 Such market discipline is needed

 The government needs to decide what proportion

of the fresh capital will go for provisions against
existing bad loans and how much is to be
allocated for new loans

 That may not seem a crying matter right now,

given the weak demand for loans

 But it is possible that companies will seek to

borrow after a few quarters if the investment
cycle does indeed turn in fiscal year 2019
Point No. 3