Feb 02, 2013 02:54 PM IST | Source:

Budget 2013-14: FM will get a bigger bank recap bill, courtesy RBI

The finance minister is not going to get his free lunch from Duvvuri Subbaro, despite the fact that the latter cut both repo and cash reserve ratio on 29 January to please him.

by R Jagannathan

The finance minister is not going to get his free lunch from Duvvuri Subbaro, despite the fact that the latter cut both repo and cash reserve ratio on 29 January to please him.

The obverse side of easier money and credit is always a higher complement of bad loans. And more bad loans means more capital. What P Chidambaram gained by way of cheaper loans will have to be repaid to banks as higher capital infusion from the government.

In a tail-sting to the monetary policy, the Reserve Bank of India yesterday announced a stringent prudential measure for banks that are restructuring bad loans with gay abandon in order to make their balance-sheets look prettier. Restructured loans are essentially loans on which the borrower has defaulted and sought the bank's acquiescence in either stretching the repayment period or reducing the loan rate, or both.

Banks are eager to restructure because otherwise they have to take a hit on profits or provide more capital. Rating agency Icra says banks bad loans are set to cross Rs 2,00,000 crore.

The RBI's new prudential guidelines on provisioning for restructured loans says that banks have to write off 5 percent of the value of restructured assets instead of the current 2.75 percent. The rate was revised to 2.75 percent only last November, and the further hike to 5 percent means that banks have to provide more capital in the balance-sheet and more provisions in their P&L account.

For all new restructured loans, the provisioning norm will be 5 percent from 1 April 2013. For the existing stock of restructured assets, the RBI has suggested a phased coverage. Provisioning in 2013-14 will rise from 2.75 percent to 3.75 percent, and in the year after from 3.75 percent to 5 percent. The crunch will thus come in 2014-15.

Not surprisingly, bank shares were swooning all over, with the BSE Bankex and NSE Bank Nifty dropping by 0.7 percent on Friday. A Bank of America Merrill Lynch report on the new RBI prudential norms said that "the biggest impact may be for Punjab National Bank (PNB), Indian Bank and Oriental Bank of Commerce (OBC) having 10 percent of loans in the restructured category. In contrast, SBI, followed by Union Bank, may be less impacted." The report says the earnings hit could be 3-8 percent for some public sector banks through 2014-15, while the impact on private banks will be negligible.

The real message of the RBI’s prudential changes is simple: banks cannot merrily keep restructuring loans as though everything is fine. They have to provide more capital.

Since the government is the largest owner of banks in India, the finance ministry will surely get a big bill for bank recapitalisation shortly, and especially in 2013-14 and 2014-15. In 2012-13, the centre provided around Rs 15,000 crore for recapitalising public sector banks, but Subbarao’s new prudential guidelines for restructured loans will make the bill bigger next year and the year after that.

Between prudential norms and Basel III – another international capital adequacy norm that is kicking in shortly – banks may have to provide over Rs 5 lakh crore of additional capital in the coming years.

In its annual report for 2012, the RBI said that public sector banks would require Rs 4.5 lakh crore of equity and long-term loans to meet Basel III requirements. For private sector banks, the figures were around Rs 75,000-80,000 crore, including both equity and loans.

The prudential norms on restructured assets will make public sector banks' capital requirements larger than ever. Public sector banks account for nearly 70 percent of the banking sector.

Perhaps aware of the likely demands for funding, the UPA government has decided that proceeds from public sector disinvestment in 2013-14 can also be used for bank and insurance companies' recapitalisation. The money may also be used to recapitalise other public sector companies outside the banking sector.

This will lead us to an incongruous situation where more public sector shares will be sold in the coming years to finance reinvestment in banks and other public sector companies.

Disinvestment money will go towards investment in the public sector. Money will go from one pocket to another for no reason other than budgetary convenience.

One wonders whether it would not have been simpler to ask banks and public sector companies to fend for themselves by tapping the market and reducing the government's stake. Isn't the time ripe for the government to start letting go of at least the smaller public sector banks?

Chidambaram should thank Subbarao for bringing that day nearer by forcing him to rethink the UPA's flawed strategy of first disinvestment, then asking LIC and banks to take up part of the disinvestment offer, and then using the same proceeds to recapitalise the insurance and banking sector. If it was anybody else but the government, it would be called a Ponzi scheme. Wonder who is fooled.

Isn't it time to abandon the charade?

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