Banking Central | What is the biggest Budget gift FM Nirmala Sitharaman can offer PSBs?

Union Finance Minister Nirmala Sitharaman

Every year, state-run banks await one key announcement in the Union Budget speech — the recapitalisation amount earmarked for Public Sector Banks (PSBs) by the Union Finance Minister. That’s the lifeline for many weaker PSBs. These banks don’t find many investors in the market unlike some of their bigger counterparts.

This year, too, the scenario is not different.

PSBs, which are owned by government and control about 60 percent of the assets of the banking system, are in need of urgent capital infusion for three reasons. One, to meet the mandatory reserve requirements 2. Provide for likely losses from stressed assets. 3. Kick-start the credit cycle as and when the loan demand revives.

Global rating agency, Moody’s, last year said the total capital requirement needed for PSBs is around Rs 2 lakh crore for next two years.

Last Budget was a disappointment for PSBs. These banks didn’t get any fresh allocation.  

Where is the money?

The Economic Survey 2021, released on Friday ahead of Budget, rightly warned about the perils of undercapitalisation in PSBs.

If capital is not provided, lenders may resort to risk-shifting, it said. In turn, impacting the real economic recovery. “Under-capitalised banks may again resort to risk-shifting and zombie lending, thereby severely exacerbating the problem,” the survey said. “The adverse impact could then spill over to the real economy through good borrowers and projects being denied credit. The resultant drop in the investment rate of the economy could then lead to the slowdown of economic growth,” the survey said.

This warning is significant since the credit growth has plunged to record low levels in the recent months on account of a range of factors including general economic slowdown and muted demand. Also, banks have been highly risk averse to lend to smaller firms due to high risk perception.

If one analyses the third-quarter earnings of Indian banks reported numbers so far, two clear trends are visible. Banks are witnessing a rise in stressed loans. Second, most lenders are trimming growth in their loans to industries on account of risk aversion. Both trends are not surprising in a slowing economy. But, banks’ lending less to companies is a clear bad news to India’s struggling economy because when credit growth slows to companies that, in turn, impacts progress of projects, cash flows and employment generation and so on.

In this context, Union Finance Minister Nirmala Sitharaman has her tasks cut for the Indian banking sector in the Union Budget 2021. The Budget is an opportunity for the finance minister to address some of the long-pending critical issues, beginning with addressing the massive capital requirement for the banks and charting out the future course of these entities.

Privatisation?

Since coming to power in 2014, the Narendra Modi-government has pumped in around Rs 3.15lakh crore in the state-run banks. But, the requirement is much too big and what has come so far is too little considering the deep mess these banks are in.

A report of the Reserve Bank of India (RBI) report recently said that the gross NPA levels could touch 14.7 percent by September this year. In simple words, this means that the banks will require more capital this year to make provisions. The Budget needs to address this part.

It is fairly certain that a fiscally-constrained, capital-starved government will not be able to meet the funding needs of PSBs in the years ahead. So what is the solution?

The better approach will be to actively pursue a roadmap for the privatisation of PSBs and get out of the ownership of these banks.

Both the UPA and NDA governments have not acted decisively on the privatisation agenda. The NDA government has only resorted to merging smaller and weaker banks with bigger ones. Last year, it undertook a mega merger exercise consolidating ten PSBs into four at one go. But experts have long argued that merger of weak banks will not solve the problem of governance issues and lack of autonomy. Besides, merging a weak bank with a strong bank could even impact the health of the big bank.

The only major bank acquisition that happened in the recent past is the LIC-IDBI Bank deal. But, this cannot be termed as a case of privatisation since the LIC is a government-owned entity.

A highly competitive market scenario, a fiscally constrained government cannot continue with the ownership of state-run banks. It will have to look at options to gradually cede ownership control in some of the public sector banks (PSBs). Sitharaman could use her Budget speech to lay out a roadmap for the privatisation of the PSBs.

Besides, the government should also look at the loopholes in the risk-management systems in the PSBs. The state-run banks continue to have weak risk management tools and are exposed to frauds. Rising frauds at banks and financial failures have shaken the confidence of customers in the banking institutions.

Privatisation of PSBs is an old agenda. The same PSBs played a crucial role in implementing Modi government’s economic agenda (including in the Rs 20 lakh crore Covid package implementation last year). Whether the government should keep PSBs alive on life support or exit from the ownership of these banks is the critical question at this stage. In 2014, the RBI-appointed P J Nayak panel submitted its report recommending privatisation of PSBs taking into account the low productivity and steep erosion in asset quality and for having “demonstrated uncompetitiveness of public sector banks over varying time periods”.

Transferring the ownership to a holding company alone will not help. The ultimate ownership matters. Strengthening PSBs is critical for the health of the broader financial system. These entities lack capital and strong managements. A solid privatisation roadmap is the biggest gift FM Sitharaman can offer to sarkari banks in this budget.

(Banking Central is a weekly column that keeps a close watch and connects the dots about the sector's most important events for readers.)