The Reserve Bank of India (RBI) has warned that the total non-performing assets (NPAs) of public sector banks in India will grow by 15.2% by the end of the current financial year. At present it is 11.3%. The warning comes in a statement issued by the Reserve Bank of India the other day.
Rating agencies and financial research institutes estimate that Indian banks will have to raise between Rs.15,000 crores and Rs.37,500 crores over the next two years in the wake of the impact on the COVID-19 economy. They point to the need for additional capital mobilisation in view of the potential for banks’ non-performing assets to grow and growth to slow.
Private banks have already moved into new transactions to raise deposits. Which way will the public sector banks, which been generally weak and, to say it colloquially, in a pregnant state’, resort to raising capital?
Leading private sector banks such as Axis Bank and Kotak Mahindra Bank are actively pursuing the mission of attracting investments. Carlyle Group, a global private equity firm, has invested Rs. 7,500 crores in Axis Bank. Kotak Mahindra Bank has raised Rs.7,460 crore through QIP (Qualified Institutional Placement).
At the same time, raising funds for public sector banks is not easy. Experts point out that public sector banks will need an additional Rs.1.5 lakh crore in capital. The government, which is facing a high fiscal deficit due to the revenue drought created by COVID-19, has limited support for public sector banks. The government has invested Rs.3.5 lakh crore in public sector banks in the last five years. No additional capital has been allocated to public sector banks in the last budget or the recently announced financial package.
In such a situation, one way is to mobilise investment through the capital market. The money raised by the government through bonds can be deposited in banks. The government has already resorted to this method. But the question remains as to how much money can be raised in this way from a market with very limited liquidity.
Another way is to privatise public sector banks. Years ago, a Reserve Bank committee headed by former Axis Bank chairman P.J. Nayak had suggested that reducing the government’s stake to less than 50 per cent was a way to increase the efficiency of public sector banks.
Public sector banks are in a situation where they are prone to sinking like a ship due to over-indebtedness and loss-making cracks. To prevent them from sinking, the government can take steps to sell the shares while maintaining a significant shareholding so as not to lose control. Bringing professionals into management from the private sector can also be a cure for the disease of mismanagement.
But even if the government is willing to sell the shares, it remains to be seen how much money can be raised through it in the current situation. Public sector banking was one of the worst hit by the stock market crash. The share price of public sector banks is currently much lower than the book value. Their share price is only 0.3 times to 0.8 times the book value. At the same time, the value of shares of private banks is still high. For example, Kotak Mahindra Bank trades at 4.7 times its book value.
It is difficult to raise the required capital through the sale of shares of public sector banks which have been devalued due to the decline in the market. Currently, even SBI, the largest public sector bank, has a market cap of just Rs.1.71 lakh crore. Shares of most public sector banks are trading at the lowest level in the last seven to ten years.
Another way is to set up an institution called ‘Bad Bank’ and redistribute the entire credit burden of the banks to it. A bad bank is an institution set up to clear the banks of all their bad debts. Bad bank will handle the burden of bad credit from then on. The only job of a bad bank is to reorganise assets. Consideration should be given to the use of asset restructuring options in the event of a long delay in the completion of the proceedings under the Pauper Act of the National Company Law Tribunal.
The job of the bad bank will be to reorganise the assets only. Consideration should be given to the use of asset restructuring options in the event of a long delay in the completion of the proceedings under the National Company Law Tribunal under the Pauper Act.
By transferring the bad debt to an institution like Bad Bank, the banks can replace the old canvas and run the loan business as smoothly as painting a new one. The old losses can be offset by the profits from the loan business. While bad credit is not eliminated, technically removing credit from the balance sheet will give banks more time to resolve issues.
In countries such as Sweden, Finland and Ireland, the practice of setting up bad banks to address the credit crunch of financial institutions has been adopted. In Asia, South Korea and China have adopted this method.
But the question remains whether the government will have to rely on the exchequer for the capital to create the new bad bank system. One way is to issue bonds for bad bank capital. Another important hurdle would be the valuation of the assets to be transferred.
