Recapitalization of Public Sector Banks: A Sensible Move, Though Late…

The government’s proposal to recapitalize the Public Sector Banks (PSBs) by injecting a massive Rs 2.11 tn with the sole motive of “support[ing] credit growth and job creation”, is a “decisive package to restore the health of the Indian banking system and a monumental step forward in safeguarding the country’s economic future.”  As the RBI Governor observed, the timing of the move too is equally laudable, for it has been taken at a time when all the macroeconomic fundamentals of the country are quite sound.  

Equally worth appreciating is the government’s style of mobilizing capital for recapitalization: It proposes to mobilize Rs 18,139 cr through budgetary provision and an additional Rs 1.35 lakh crore by issuing recapitalization bonds, while the rest of the amount is expected to be raised by banks themselves through public issue. 

Issue of recapitalization bonds is a deft move for reasons galore: one, it enables the government to front-load capital injection while it could stagger the accompanying fiscal implications over a period of time; two, mobilization of such a staggering amount would not pose a problem for the government since banks are sitting pretty with huge cash surpluses owing to the recent demonetization; three, issue of recapitalization bonds will be liquidity neutral for the government except for the interest expense that will contribute to its annual fiscal deficit;four, it also enables banks to rope in private investors by accessing capital market to mobilize a part of the envisaged amount;  and five, the exercise  of recapitalization of banks is taking into account not only the current NPAs of banks,  but also what is likely to happen in the coming two years. Thus the whole game plan, as the RBI Governor commented, is flavoured by “several desirable features”.

However, there are critics who are averse to the government recapitalizing ailing banks at a cost to the exchequer. The fear of ‘moral hazard’ has also been brought in by these critics. According to them, it is the government’s ownership of the banks and the resulting inefficiency in their governance that is mainly responsible for the costly bailout, that too, at frequent intervals and hence advocate banks’ privatization.

They might be partly right for there is much to be desired in the way the banks are today governing themselves. But bailing out of banks from financial crisis is not unique to India alone. Indeed, major banks, though privately owned in western countries, have experienced periodic bouts of such failures. Incidentally, IMF statistics indicate as many as 140 episodes of banking crisis in 115 countries during the period 1970 to 2011 and the cost of recapitalization of the banks in these countries was said to be around 7% of GDP. As against this, India’s cost of recapitalization is perhaps less than 1% of GDP over the last two decades.   This, of course, doesn’t mean that India need not be concerned about the huge cost underlying the recapitalization of banks.

Obviously, when viewed  against this backdrop, government’s present action of  launching “a  comprehensive and coherent” plan of action to address the whole gamut of banking sector ills in one go well fits into the reform mantra that pundits are talking about all along. However, the government must adopt a calibrated approach of funding the balance sheets of such banks which are ready to clean up their mess effectively and could quickly undertake credit dispensation in preference to those who are slogging to come to terms with the correction warranted. Such a move shall inject a kind of discipline too among the players, which is sure to be appreciated by the capital market when they approach it for equity.  

Over and above it, what is more important for this move to succeed is: empowering the Bank managements to take quick decisions regarding one-time settlements or on writing off of NPAs by affording protection for commercial decisions from the agencies like Central Vigilance, CBI, etc. As Deepak Parekh, Chairman, HDFC, observed, “Let a situation like IDBI Bank executives not happen.” For, that is sure to dampen the will of executives to take critical decisions.

At the same time, government, being the major stakeholder, must encourage banks to pursue recovery of bad debts aggressively through all the available means, including launching insolvency proceedings under the recently launched IBC against the defaulting borrowers. Here again, desisting its temptations to dole out political favours, government must stay away from the banks’ decisions relating to management of bad debts. Simultaneously, government should strengthen the tribunals to dispense judgements under insolvency petitions with no time losses. Aggressive pursuit of bad debts through IBC, is of course, sure to create crisis like situation in the business circles, but it is a must to give a befitting treatment to the erring investor so that others are deterred from resorting to such deliberate acts defaulting from repayment of bank loans.

The next priority for banks wold be focusing on their credit-culture: the “unique combination of policies, practices, experience and management attitudes that defines the lending environment and determines lending behavior acceptable to the bank.” It manifests as the “shared belief of lending being done on the basis of prudent, commercial and profit-oriented criteria. Any deviation from the line is likely to result in lending being done for non-commercial reasons and in the process end-up in poor quality loan assets. A poor credit culture of a bank may ultimately result in: NPAs. The owner should therefore demand from the managements to hone up the credit culture.  And as a first step in this direction, the owner of the banks, the Government, should exhibit moral courage to distance itself from the credit decisions being taken by banks.  For, any such intervention is certain to skew the credit decisions of banks leading to the flow of capital into wrong hands, which ultimately tends to end up as bad debt. Secondly, it is only through such distancing itself from the decision making in banks that the  government can demand accountability from the mandarins of the banks for the right management of capital placed in their hands.

This should be followed by constitution of bank boards with professionals backed by proven track record, particularly with people of upright character. Secondly, CEOs must be selected transparently and they must enjoy a fixed term of minimum five years. Indeed, a thorough revamping of banks’ HR Policies is what is immediately called for to realize the full benefits of the proposed recapitalization. Else, NPAs being of recurring nature, tend to resurface soon.