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Two reasons why India’s cash-starved govt banks need urgent capital support now

If the govt wants PSBs to shoulder the burden of the economic package execution, simultaneously fighting the COVID-19 uncertainty, it needs to fill their capital void. Else, it needs to prepare a plan to get out of government ownership in these banks and let private players run the show.

May 28, 2020 / 05:08 PM IST

The Narendra Modi government has so far refused to announce any capitalisation plans for PSU banks for this year. Union Finance Minister Nirmala Sitharaman didn’t announce any capital for banks in the last budget. The expectation was that the government will do that in the economic package. But even there, PSU bank capitalisation was given a miss. This has put government banks, which control 60 percent of the assets in the banking industry, in a difficult spot. These entities are desperate for capital.

Credit Suisse has pegged the total capital requirement for Indian banks over the next 12 months at $20 billion (around Rs 1.5 lakh crore). Of this, state-run banks may need around $13 billion (around one lakh crore). In the 2020 Union Budget, Sitharaman had said that PSU banks will be encouraged to raise capital on their own. But this isn’t a possible solution since, in the present market scenario, it won’t be easy for most of these banks, saddled with sticky loans, to lure investors.

Banks urgently need capital for two reasons.

1) To make provisions on bad loans in the wake of COVID-19 shock.

Provisions are funds banks need to set aside under the Reserve Bank of India (RBI) norms to cover likely losses from loans. In a bad economic scenario, provisions can jump multifold. According to Fitch ratings, Indian banks’ bad loans are likely to go up by Rs 5.5 lakh crore on account of the impact of COVID-19. The prolonged nationwide lockdown that began in late March has brought economic activities to a standstill. This means more borrowers will default on loans now. The RBI has announced moratorium for six months (March-August) to help the borrowers tide over the crisis phase. Most of the banks have seen loans under moratorium ranging from 25 percent of their loans to 70 percent. How many of these borrowers will resume payments once the moratorium period is over is key to watch. It all depends on the evolving economic scenario.

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“The latest set of measures announced by India's central bank include an extension of the 90-day moratorium on recognition of impaired loans to 180 days, in addition to several relaxations in bank lending limits including allowing banks to fund interest on working-capital loans,” Fitch ratings said in a report on Thursday.

“These measures will put a heavy onus particularly on state banks (with already-weakened balance sheets) to bail out the affected sectors, due to their quasi-policy role, considering that much of the state's recently announced stimulus measures is in the form of new loans,” Fitch said.

To cut a long story short, there is a great deal of uncertainty on how the bad loan cycle will evolve from here. It will worsen for sure, but no one knows to what extent. Most economists predict GDP growth to contract to negative five percent. If the lockdown prolongs, the asset quality in the banking sector can get severely impacted. Banks have ramped up significant provisions in the fourth quarter in view of the COVID-19.

2) To lend afresh to productive sectors

Bank lending revival is key to growth revival. Banks also need money to start lending to economically weaker sections. A large part of the government’s Rs 20 lakh crore economic package is founded on loan schemes. These include a Rs 3 lakh crore MSME loan scheme, Rs 2 lakh crore concessional credit to farmers, Rs 5,000 crore credit to street vendors and loan schemes targeting non-banks. That apart, the RBI too had announced a slew of liquidity schemes to make headroom available for banks to lend to specific segments.

“There is no doubt that banks need fresh money now, especially state-run banks. The government hasn’t announced anything so far. This has to happen soon,” said Siddharth Purohit, an analyst at SMC Global Securities.

Against the backdrop of this, banks will come under tremendous pressure in the months ahead to meet specific lending targets. At the same time, banks need to deal with uncertainty on the asset quality front. Banks will need a significant amount of capital in view of this situation.

How can a fiscally constrained government fund PSBs?

Obviously, the government doesn’t have any fiscal space left for extra spending. Even the extra borrowing of Rs 4.2 lakh crore announced recently was aimed at filling the gap arising out of revenue losses. But, the recapitalisation of PSBs need not be direct equity infusion. It can happen through recapitalisation bonds as well.

If the government wants PSBs to shoulder the burden of the economic package execution, simultaneously fighting the COVID-19 uncertainty, it needs to fill their capital void. Else, it needs to prepare a plan to get out of government ownership in these banks and let private players run the show.
Dinesh Unnikrishnan
first published: May 28, 2020 03:49 pm

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