Are Recapitalisation Bonds The No Brainer Solution To India’s Bank Capital Woes?

Each time public sector banks, the government or the regulator have tried to come up with a solution for bad loans they hit upon one problem – the lack of adequate capital.

The Reserve Bank of India (RBI) says that banks aren’t moving fast enough on bad loan resolution. Banks say they would, if the government gave them enough capital to take steep haircuts. The government says it would provide the capital if only it had fiscal space.

Lack of capital is where the discussion hits a brick wall.

But is everyone missing a seemingly obvious solution? One which has been successfully used in the past. The use of bank recapitalisation bonds.

Consider the prevailing conditions in the market. Banks are flush with liquidity. Deposits that came in during demonetisation have proved to be sticky. Credit demand, however, remains low. The result has been that banks have been parking funds heavily in the debt securities – both government and corporate.

Central government borrowings, meantime, remain in check with gross borrowings for the current fiscal pegged at Rs 5.8 lakh crore. State government borrowings, however, are expected to be higher and inch up due to the recent farm loan waivers. Still, the market remains well supplied with liquidity and anyone who needs funds is being able to raise it at reasonable risk-adjusted rates.

Also Read: Government Will Infuse Rs 2.11 Lakh Crore In State-Run Banks In 2 Years

The government, should it choose, can use this comfortable liquidity scenario to raise funds through an issue of bank recapitalisation bonds.

Essentially you can use the money available with banks to recapitalise them. As a collateral benefit, you can also reduce the liquidity sloshing around in the system.

In a recent interview with BloombergQuint former Reserve Bank of India (RBI) governor YV Reddy highlighted that 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.

Explaining his view, Reddy said that since there is no threat to the solvency of the banking system, capital has to be provided essentially to meet regulatory requirements. If that is the case, recapitalisation bonds or callable capital should suffice as a way to resolve the existing problem.

Former RBI deputy governor HR Khan shared a similar view with BloombergQuint earlier this week. Such bonds could prove to be an ideal solution to the problem of bank capital without hurting the government’s fiscal position, said Khan. He, however, added that the banks should also look to raise funds on their own through the stock markets which are currently buoyant.

Rating agencies have been flagging off the inadequate availability of bank capital for some time now. In June, Moody’s Investors Service estimated that just the 11 banks rated by them would need Rs 95,000 crore by March 2019 to ensure that Basel III requirements are met. The government, so far, is planning to infuse Rs 10,000 crore each in fiscal 2018 and fiscal 2019. It has, however, indicated that more capital will be made available to banks if needed.

According to the June edition of RBI’s Financial Stability Report, the system level capital adequacy ratio stood at 13.3 percent in March 2017. Under the assumed baseline macro scenario, two banks may have CRAR (capital to risk assets ratio) below minimum regulatory level of 9 percent by March 2018, said the report. However, if macro conditions deteriorate, six banks may record CRAR below 9 percent under severe macro stress scenario, it added.

A senior government official told BloombergQuint on condition of anonymity that a final estimation of the additional capital needed should be arrived at soon. Once that is done, the government will take a call on whether the funds are available within the budget or other means of raising capital need to be considered, said this official while adding that all options including recapitalisation bonds will be considered.

One reason why the government may not be convinced about recapitalisation bonds is the view that rating agencies may take on the issue. In the past, rating agencies have frowned upon so-called ‘below the line’ fiscal items. This includes securities like oil bonds, fertiliser bonds, which, in the past, have been used as a way to avoid a bloating of the fiscal deficit.

Still, in a scenario where the government is considering pushing back the full implementation of the Basel III capital norms, raising funds through an instrument like recapitalisation bonds may be preferable to sending out a message that the Indian government, which continues to be the majority owner of the banking system, is not in a position to capitalise its banks.

Ira Dugal is Editor - Banking, Finance & Economy at BloombergQuint.

This article has been amended to remove a comment from India Ratings.