(Photographer: Dhiraj Singh/Bloomberg)

State-Run Banks To Get Rs 2.11 Lakh Crore Capital Boost

The Indian government on Tuesday announced an allocation of Rs 2.11 lakh crore over two years for the recapitalisation of public sector banks. The plan is intended to help banks make adequate provisions against bad loans and revive lending, which, in turn, may help support a recovery in the economy and private investment.

The recapitalisation plan is split into two parts, Banking Secretary Rajiv Kumar explained at a press conference in New Delhi. A bulk of the capital - Rs 1.35 lakh crore - will come via the issue of recapitalisation bonds. The remaining Rs 76,000 crore, which includes Rs 18,000 crore already allocated under the Indradanush Recapitalisation Scheme, will come through budgetary support over two fiscal years.

By recapitalising banks through a mix of bonds and cash infusions, the government hopes to avoid breaching its fiscal deficit targets.

Globally, there are certain categories of recapitalisation bonds which are not counted as part of the fiscal deficit, said Finance Minister Arun Jaitley at the press conference when asked whether the deficit target of 3.2 percent of GDP for the year would be breached.

Chief Economic Adviser Arvind Subramanian explained that under International Monetary Fund rules, recapitalisation bonds do not impact fiscal deficit. But “our rules say that funds raised through bonds would be a part of (government) debt,” he said.

Big Relief For Banks

The recapitalisation plan comes as a big relief for capital starved banks, who have been struggling to provide for stressed assets. Bad loans in the Indian banking sector have crossed Rs 8 lakh crore following an asset quality review conducted in 2015.

In addition, banks also need capital to transition towards the full implementation of Basel 3 norms. Under the Basel 3 implementation roadmap, banks need to increase total capital (including the capital conservation buffer) to 10.875 percent by March 2018 and to 11.5 percent by March 2019.

An earlier government plan to infuse Rs 70,000 crore into state-owned lenders between fiscal 2016 and fiscal 2019 was seen as inadequate to meet the capital requirements. The government was keen that banks supplement this by raising capital on their own through equity issuances and sale of non-core assets. Lenders have found it tough to do this, leaving them undercapitalised.

The fresh capital will help meet the needs of banks, said Rajnish Kumar, chairman of State Bank of India

The Rs 2.11 lakh crore is adequate to cover for Basel 3 requirements and support credit offtake after that. There is a good possibility of growth and credit demand in the future.
Rajnish Kumar, Chairman, State Bank of India

The capital provided is enough to take care of 80 percent of the capital requirement of banks, said VG Kannan, chief executive officer of the Indian Banks Association.

Abizer Diwanji, head of financial services at EY noted that the quantum of allocation is significant and will help ease the pressure on these lenders to a large extent. "This amount is around half of Rs 4.5 lakh crore which is the market capitalisation of all public sector banks put together,” said Diwanji.

While the government has not detailed the manner in which capital will be allocated within banks, some banks need capital more urgently that others.

Banks which had the lowest capital adequacy ratios at the end of the June included Central Bank of India (9.61 percent), UCO Bank (9.69 percent) and Corporation Bank (10.62 percent). IDBI Bank, which was at risk of skipping coupon payments on its Additional Tier-1 bonds, received capital infusion from the government in August. Among the larger banks, State Bank of India had a capital adequacy ratio of 13.31 percent, Bank of Baroda of 11.81 percent and Punjab National Bank of 11.64 percent.

State-Run Banks To Get Rs 2.11 Lakh Crore Capital Boost

What Are Recapitalisation Bonds?

Much of the capital infusion will come via bonds. The issue of recapitalisation bonds will essentially mean that the government issues bonds to banks in lieu of capital. Lenders will subscribe to these bonds as part of their investment portfolio. The money raised by the government will then be used to infuse fresh equity into banks.

Such bonds had been used successfully in the 1990s. Back then, in a very similar situation, the government issued recapitalisation bonds, which banks subscribed to. The funds raised thereof were used to infuse capital into banks that needed it.

While recapitalisation bonds will increase the government’s liabilities and be seen as a below-the-line fiscal cost, it may prevent an additional burden on the government’s finances in the immediate term.

The plan does not have any immediate implications for the fiscal deficit this year or the next, Saugata Bhattacharya, chief economist at Axis Bank told BloombergQuint. Since part of the funds are being raised by issuing bonds, it will not add to the Centre’s fiscal deficit, except for the interest paid on those bonds, he added.

Still, the size of the recapitalisation plan may lead to a negative reaction in the bond market, where yields are expected to rise.

“The market will definitely react. They’re in a mood to react,” said Jayesh Mehta, country treasurer at Bank of America. He expects a 4-5 basis point uptick in the 10-year sovereign bond yield. Mehta, however, added that the plan is cash flow and liquidity neutral and will increase banks’ appetite to invest in other paper since they now will have the capital to do so.

Watch BloombergQuint’s analysis of the mega bank recapitalisation plan here.

Read all the updates from the Cabinet briefing here.