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So far, PSBs are the unsung heroes in Rs 20 lakh crore stimulus package. But who will rescue them?

Collateral-free loans carry a risk of companies misusing the government scheme in collusion with local bank officials and politicians.

May 15, 2020 / 09:02 AM IST
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Much of the Rs 20 lakh crore economic package announced so far by Union finance minister Nirmala Sitharaman include bank loans and interest rate subsidies. There is very little fresh stimulus in the economy from the government.

In other words, the real onus of rolling out the economic  package promptly falls on  state-run banks and institutions like NABARD. This will be a bit tricky for these lenders because in a faltering economy, a good chunk of these loans could go bad later.

Take a look at the key announcements so far. In her first press meet on May 13, Finance Minister Nirmala Sitharaman said banks will disburse Rs 3 lakh crore worth collateral-free loans to micro, small and medium enterprises (MSMEs) backed by government guarantee. These loans will have one-year moratorium and a four-year repayment period. Also, Rs 75, 000 crore lending has been earmarked for NBFCs and MFIs.

On May 14, Sitharaman continued with loan schemes. She announced Rs 2 lakh crore concessional credit for 2.5 crore farmers through new Kisan Credit Card route, Rs 30,000 crore emergency working capital fund through NABARD, 2 percent interest subvention on Mudra loans less than Rs 50,000 and Rs 5,000 crore credit facility for street vendors. Logically, PSBs will be under tremendous pressure from now on. They will be asked to kickstart the disbursement of loans to meet the targets set by the government.

Track this blog for highlights from second day of FM press meet

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Typically, whenever a government scheme is announced, be it loan waiver or some sort of directed lending, PSBs are given informal targets. This happened during the rollout of Jan Dhan bank accounts and back-to-back loan waiver schemes across states. This time also, the scenario can't be too different.

Additional pressure on banking system

Banking system is already reeling under the COVID-19 crisis. Many banks have seen signs of stress in customer segments. Most of the banks have made upfront provisions (funds set aside to cover risky loans) to cover COVID-19 induced losses. At a time when banks are already facing a crisis scenario, collateral free loans and fresh KCC loans are likely to put more pressure on the system.

Even with government guarantee, collateral-free loans to MSMEs carry high potential risk in the banking system. Similarly, when it comes to Rs45,000 crore partial credit guarantee scheme, government has promised to take only 20 percent losses in the event of default. Banks will have to take the risk for remaining 80 percent.

Additionally, collateral free loans carry a risk of companies misusing the government scheme in collusion with local bank officials and politicians. In the past, this has happened rampantly in the co-operative banking sector. There is no scope of recovery since there is no collateral against the loans.

Also, there is a strong possibility of banks overlooking the creditworthiness of the borrower in a hurry to meet the government targets. Without proper mechanism to assess the end use of these loans and strict conditions linked to performance and staff retention, the collateral free loans may not yield the desired results. Also, in a slowing economy, such loans could emerge as a fresh risk to the banking system eventually.

The Covid scenario may increase the capital requirement of PSBs substantially once the loan moratorium period is over. A good chunk of the existing loans are likely to turn bad. The government has not yet announced a plan on how to recapitalize these banks. The PSB banks are in need of urgent capital support.

Capital woes

According to BofA Securities, Government-owned banks’ non-performing assets (NPA) could go up by 2-4 percent of the credit in the present economic environment. This, BofA says, will result in a recapitalisation requirement of $7-15 billion (Rs 1.14 lakh crore at the upper end).

How can the government fund these banks? With revenues falling short of expectations and disinvestment not happening, the government is already walking a tight rope on fiscal discipline(expected around 5.5 percent this year). The decision to borrow Rs4.2 lakh crore additional itself was part of an emergency measure to cover the likely revenue losses.

But, banks need capital. How will a cash-starved government do this? A recent BofA report suggest two practical ways. One, through recapitalisation bonds. Recapitalisation bonds are instruments that will be issued by the government to infuse capital in state-run banks. Banks can subscribe to these bonds against the capital infused in them by the government.

“This should help PSU banks heal their broken balance sheets and meet adequate capital requirements. Once growth recovers, the government can gradually convert these recap bonds into normal G-secs and sell them to the market, as happened in the past, BofA said.

The government could also look at using RBI’s revaluation reserves to capitalize banks, BofA Securities said. According to BofA, the RBI's revaluation reserves of Rs 9.6 lakh crore can also be utilised to recapitalise banks in a fiscal deficit-neutral and liquidity-neutral manner.  The RBI's revaluation reserves currently provide appreciation cover till Rs 54.20/$. Utilising Rs 1 lakh crore to recap PSU banks will still maintain a cover of Rs 56.40/$, the report said.

Merely capitalizing banks isn’t enough. Government needs to find a way to address the existing stock of bad loans as well (around Rs8 lakh crore now). The ‘bad bank’ or an entity to which all NPAs in the system will be transferred is being discussed. There is no clarity yet on the structure and capital infusion plan.

Unless the economic situation on the ground improves, it is unlikely that the bad loan resolution will happen effectively. And there will be the fresh chunk of NPAs that will arise in a Covid-wrecked economy. Banking sector will need government's hand holding to tide over the crisis phase. Nirmala Sitharaman’s two press conferences have been silent on this part so far.

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Dinesh Unnikrishnan

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