Bank Recap: In the End, India's Taxpayer Pays for Cronyism

While the government needed to kick-start growth and private investment, it is absolutely essential that promoters of defaulting corporate groups don't end up laughing all the way to the bank.

Finance minister Arun Jaitley: Is his bank recap plan a little too late? Credit: Reuters

Finance minister Arun Jaitley: Is his bank recap plan a little too late? Credit: Reuters

The Centre’s decision to recapitalise banks with government bonds worth Rs 1.35 lakh crore is nothing but the taxpayer bailing out India’s public sector banks whose capital base stands eroded because of mounting loan defaults by 50 large corporate groups.

Though the government says this won’t increase the fiscal deficit as no cash outflow is involved, it does have other effects of a higher fiscal deficit such as increased interest payment by the government on the bonds issued to banks. Chief economic advisor Arvind Subramaniam in a press conference on Tuesday said it would increase government borrowing and technically crowd out the private sector. But he hoped the freshly capitalised banks would lend more to productive sectors and neutralise the crowding out effect.

Former RBI governor Venugopal Reddy told The Wire that if banks hold government securities in lieu of equity capital, then the Centre can justify this in future if the dividends received by it from banks exceed the interest it pays on the bonds. In short, the banks must generate enough profits and pay dividends to the Centre to justify recapitalisation through government bonds.

One could argue this was the only option left with the government as PSU banks had virtually stopped lending to the private sector because their capital base was substantially eroded due to heavy corporate loan defaults. So infusing fresh capital had become an absolute necessity. However, it is not clear whether the large defaulting corporate groups have been squeezed enough and made to pay the price for their mistakes and misdemeanours. The most critical question, in this context, is whether some of these well-known corporate groups should be declared wilful defaulters as there is ample evidence of their having diverted these funds for purposes other than the projects for which the loans were granted.

A labourer carrying dry leaves walks past a Reserve Bank of India (RBI) building during a nationwide strike in Kolkata, India September 2, 2016. Credit: Reuters/Rupak De Chowdhuri/File Photo

A labourer carrying dry leaves walks past a Reserve Bank of India (RBI) building during a nationwide strike in Kolkata, India September 2, 2016. Credit: Reuters/Rupak De Chowdhuri/File Photo

Recently, finance minister Arun Jaitley candidly admitted that the bad loan problem was largely confined to some 50 large corporate groups who had indiscriminately borrowed from banks to set up steel and infrastructure projects, especially in the power sector. These groups alone would account for over 80% of the total NPAs and stressed assets in the banking system. Latest data shows that the total NPAs and stressed assets are in the range of Rs 13 lakh crore to Rs 14 lakh crore. And these are politically, well connected corporate families who dominate election funding.

So one would like to see which set of PSU banks the R.1.35 lakh crore of government bonds will recapitalise in the first phase. This is very important because out of the 22 odd PSU banks, about 8 to 10 large banks are the ones who have lent generously, as part of a consortium, for the same projects which have gone sour and resulted in big defaults.

The finance ministry did not give details of which banks will receive the funds but Arun Jaitley did clarify that the recapitalisation will be accompanied by new banking reforms and conditions which “will ensure this situation does not recur”. Jaitley also blamed the previous government for the massive rise in the bad loans. But what Jaitley cleverly hid was the fact that his own government took full three years to take the bull by the horn and the bank balance sheets greatly deteriorated in this period. The PSU bank’s gross NPAs have doubled in 3 years – from about 4% of net bank credit to nearly 9% today.

Also read: Explained – The Great Indian Bank Recapitalisation Push

Until mid 2015, the market value of PSU banks had not fallen so much. It was known even then that PSU banks would need about Rs.2.5 lakh crore of fresh capital. But for some reason the NDA government postponed taking action. The banks needed a one-time big dose of capital but the finance ministry preferred the piecemeal approach by adding very small doses of fresh capital. If fiscal deficit was its concern, it could have done in 2015 budget what it has done today – make a big infusion of capital which is fiscal neutral.

But by postponing the big capital infusion, the finance ministry let the problem of bank capital fester and by March 2017 the market value of the entire public sector bank universe had collapsed by about 50%. This deterioration was playing out before our eyes even as private banks and NBFCs grabbed two-thirds of total lending in this period.

In January 2016, The Times of India reported that the stock value of just one private bank HDFC became equal to that of 21 nationalised banks including the SBI. These 21 banks controlled 70% of the outstanding credit market compared to HDFC’s 6% . And yet, HDFC’s stock price was equal to that of 21 PSU banks put together. This was the first big warning that all was not well with PSU banks. The situation has probably worsened today. In early 2017, there was the expectation that demonetisation would extinguish enough black money to enable a big infusion – about Rs 3 lakh crore – of fresh capital in banks. But that did not materialise. PSU bank lending growth registered a multi-decade low in the nine months after demonetisation. Having failed on this front, the finance ministry is now embarking on recapitalising banks on an urgent basis.

So clearly the big action from the finance ministry has come three years too late.The ministry expects these banks to additionally raise about Rs.56,000 crore from the market quite apart from the government recapitalisation efforts. Hopefully the IPO market will have enough appetite to absorb equity issues from just one sector.

Overall, the story is one of the taxpayer bailing out the banks and defaulting corporate groups whose promoters will still end up laughing all the way to the bank.