Public sector banks are not capital scarce. Rather than recover the humungous NPAs, vested interest groups want them to raise capital, in other words, privatise, by citing Basel III as a pretext
A remarkable observation by RBI Governor Raghuram Rajan has not received the attention it deserves. Rajan told the Economic Times recently, “I don’t think anybody needs capital immediately.”
Let’s place his candour in perspective. So far the central bank’s position has been that banks would need capital to meet Basel III norms. Under this scheme of things, restructured assets would no longer be treated as standard assets; as a result the balance sheet provisioning by Indian banks would have to be raised from 5 per cent to 15 per cent of outstanding loans. Yet, Rajan has virtually ruled out additional capital needs for the time being!
In doing so he has debunked the conclusions of the RBI’s own working group headed PJ Nayak that estimated bank capital requirements for Basel III compliance at a massive Rs 5.87 lakh crore. Rating agencies like Crisil seem to support this assessment.
Crisil’s estimate is Rs 3.4 lakh crore for becoming Basel III compliant. The same goes for Fitch ratings, now called India Ratings. But rating agencies have their own interests in making these estimates. They derive their fees from the ratings of the capital bonds issued by the banks.
So, Rajan is in effect posing a basic question: Do Indian banks really need that amount of the capital?
India and Basel III
Indian banks have been one of the earliest adherents to Basel III; they started the compliance exercise way back in 2011, after the Bank for International Settlements made its recommendations in December 2010.
Among the key recommendations of the new Basel III standards are a minimum ratio of total capital to risk weighted assets of 10.5 per cent, tier one capital to risk weighted assets of 6 per cent and leveraging ratio of 3 per cent. The deadline for achieving all these milestones is 2019.
The capital to risk weighted assets of Indian banks has remained high, averaging 11 per cent till March 2014. As for the second requirement, the actual achievement of the Indian banking system was 8 per cent. That leaves only the leveraging ratio. Basel III fixes a minimum threshold net worth of 3 per cent against all the bank assets. The leveraging ratio is a cap on bank assets in relation to its tier one capital. It essentially implies more common equity for riskier assets including derivatives. The purpose of this ratio is to contain excessive build up of financial derivatives and is an additional regulatory tool. Even here, Indian public sector banks have exceeded the standards. The tier one capital (equity plus reserves) was 6.2 per cent for Indian banks, and 5.2 per cent for public sector banks.
These norms drawn up by the BIS don’t indicate any capital deficit in the Indian banking system. Instead, the issue of capital requirement arises from the fact that in order to sustain a GDP growth of 7.4 per cent, credit would have to grow by at least 15 per cent. However, credit growth has remained muted, despite the series of interest rate reductions initiated by the RBI, under pressure from the Finance Ministry.
In fact, non-food credit growth slowed to 9.7 per cent during the fiscal year 2014-15. The single reason for the lackadaisical credit growth stems from shrinking investment in the economy. Gross fixed investment since the Narendra Modi-led BJP government assumed power has actually fallen from 29.7 per cent to 28.7 per cent of GDP.
Against a credit slowdown, there is little need to expand bank capital. So where is the pressure to expand bank capital coming from? Answer: the burgeoning non-performing assets (NPAs). Or, to flip the argument, if the NPAs are recovered, there may be no need to raise capital, at least at prevailing levels of credit growth. Is that what Rajan is saying?
NPAs: India and the West
So, what’s the NPA issue all about?
Unlike the western banking system, Indian banks’ capital needs are not prompted by credit card delinquencies, derivatives or depreciation in the value of mortgage backed securities. Such assets are a minuscule part of the portfolios on their asset books. The NPAs are just loans that have not been repaid on time. As a result, they would have to be ‘provisioned’ out of, or set off against, operating incomes.
Simply put, it means that borrowers are unable, or unwilling, to repay loans. Non-performing loans are estimated at 4.5 per cent in fiscal 2015 by rating agency ICRA. In actual numbers, that translates to about Rs 2.95 lakh crore of the Rs 66 lakh crore of gross credit during the period!
In reality, the unpaid loans are actually understated, since there is another classification called restructured advances. It simply means that banks have conceded to borrowers’ demands for more time to repay. Restructured advances amounted to Rs 2.8 lakh crore. This implies that the effective NPAs in the banking system are closer to Rs 6 lakh crore.
But the NPA and restructuring classification do not include another banking practice of ‘whitewashing’ bad assets by converting them into equity, a procedure refined by India’s largest private sector banks. The practice allows for under-provision on loan losses and, in turn, the showing of high profits or high shareholder returns.
As a result of such creative accounting, Kingfisher is a bad asset in the public sector banks’ books and a good asset in that of private sector banks! Besides Kingfisher, there are others like Bhushan Steel, a newspaper group, steel, cement and mining companies.
High loan writeoffs imply that the bank bears the loss and in turn faces capital attrition, translating into solvency pressures. This is what raises the issue of capital demands for public sector banks. In 1993, the erstwhile New Bank of India faced these pressures, prompting government intervention and subsequent merger with the Punjab National Bank.
Unlike in the Western banking system, loans made by Indian banks have to be secured against collateral or corporate guarantees. The value of a collateral or corporate guarantee is normally about 1.5 times the loan value. The SARFAESI (Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest) Act, empowers banks to enforce recovery of delinquent loans from defaulters. Where collaterals are encashed, the capital pressure on banks is mitigated considerably.
But bad debts in the Indian banking sector are a political economy problem. According to a statement made by Minister of State for Finance Jayant Sinha in the Rajya Sabha, “the top 30 non-performing assets of public sector banks amount to Rs 95,122 crore as on December 2014.” The minister said on the floor of the House that gross NPAs of PSU banks amounted to Rs 260,531 crore on December 2014, which means that the top 30 accounted for 36.5 per cent of total PSU bad loans. Even the disclosed figures were exclusive of restructured assets.
This issue was, in another way, admitted by United Bank of India chairman P Srinivas. He was quoted as saying, “We are not getting any amount. We ultimately get a few more crores by selling that building (Kingfisher House in Mumbai) and other collaterals. But when you look at the total loan amount, what we may ultimately recover is just equivalent to the interest component.” The 17 lenders to the UB Group have been able to recover just Rs 1,000 crore out of their Rs 7,500 crore exposure, excluding penal interest.
The defaulters have compromised the domestic banking system. But rather than highlight this fact, a set of vested interests is pushing for privatisation (reducing public stake to 33 per cent) and capitalisation as alternatives to debt recovery. Raising capital through fresh equity offerings may not be feasible if asset values are to be written off, as that might create an unfavourable pricing environment, raising objections from the Comptroller and Auditor General or the Central Vigilance Commission. Better, then, to let the big defaulters be – good old crony capitalism, in other words.
Government pressure to reduce interest rates appears intended to weaken the public sector banking system and pave the way for privatisation. After all, it is surplus interest income that generates internal resources for making provisions, creating reserve funds, generating the highest quality of capital, and above all providing returns to the government for meeting its non-taxable revenue resource target. The benefits of lowering interest rates for growth need not be disputed here. PerhapsThe RBI can bring back a differential interest rate system to meet different economic objectives.
But policies are driven by a distorted agenda, which the corporate-driven media has chosen to ignore.
C. Shivkumar is a journalist who has worked at Business Standard and Business Line. He specialises in financial markets, banking, project finance and bond markets