Sunday, November 1, 2015

Capital Infusion in PSBs – Need and the Deed

Capitalization of Public Sector Banks has been incorporated as one of the seven items in ‘Indra Dhanush’, dubbed as part of Banking Sector Reforms.  Before addressing the issue of such capitalization it is important to understand some of the historical developments in banking globally and the way different countries responded to addressing the issue of refurbishing capital in the banks.

As part of the global financial system, Reserve Bank of India made us to believe that banks in India have to fall in line with capital adequacy norms under Basel regulations. Even prior to the embrace of capital regulations of Basel India had CRR and SLR as regulatory instruments to safeguarding the financial stability of banks. 70 percent of the Banks’ assets in India are in the public sector.

Even though the Committee on Banking Sector Reforms in 1998 recommended that Government of India should shed its stake in the banks and provide autonomy, accountability and transparency to banks GOI did not agree on stake reduction. During NDA -1 regime, the then Finance Minister mooted the proposal to reduce the stake of Government to 33 percent from 51 percent (In fact in some banks the share of the Union Government is as high as 60 percent), the Parliamentary Standing Committee did not agree and the proposal fell flat.

On the other hand, Government of India picked up the RBI’s stake in the SBI and NABARD. Thus Union Government’s ownership in banks has only expanded vastly since 1998.

Apace with these developments view the global acceptance of the Basel Norms that has invariably been cited as the raison de ‘etre for periodical capital infusion in the banks. US Fed did not agree for imposing the Basel II norms even and did not at all agree for the deadlines for Basel III introduction from April 2019. Its Community Banks that have a share of over 40 percent of US Banking are still away from Basel II. Yet the Moody’s or Fischer or any other global rating institutions did not down rate the US Banks on such count. But when it comes to India, Basel norms have become rule niche to down rate the banks.

Akin to the diversity in the nation, banks are also quite diverse in their structures and contribution to the society and economy. We have PSBs, new generation private banks, old private banks, regional rural banks, local area banks, foreign banks, urban cooperative banks and rural cooperative banks (state cooperative banks and the district central cooperative banks). Two more are joining the fray shortly: the payment banks and small banks. Should all these banks diverse size and nature of operations conform to the capital adequacy norms under Basel alike?

Banks should have adequate capital to run their business on sound lines. They should also be able to withstand the market shocks and global shocks of the like that we experienced in 2008, following recession or a similar impending shock following the Yuan shock now. There can be no two opinions. Deciding on the quantum of economic capital and regulatory capital they should hold is the prerogative of the regulator. The question now is: should it be of equal level for all the banks from a date decided by the RBI? Has this something to do with the NPAs that are growing year after year during the last three years?

Global Compulsion:
RBI recently classified by asset size two Banks, SBI and ICICI Bank (D-SIBs) as systemically important and should hold higher capital than others. It considered that their failure will have a cascading effect on the financial system and the economy. Although the RBI has followed the broad principles laid down by the Basel Committee for making such a selection it reckoned local conditions as well. For instance, it has concluded, and rightly, that the capital adequacy norms for D-SIBs need not be as stringent as stipulated for global banks. It could have categorized at least six more banks as D-SIBs. If these alone could qualify for additional infusion of capital given the fact that all other banks are range bound 9-12 percent the need for capital infusion would not be of the order projected in 2012 by the RBI at Rs.5trn. The RBI has also taken cognizance of the fact that burdening banks with too much capital will be counter-productive, given the already weak credit growth. Those small banks, rural banks etc that cater to the needs of customers in localized or specific compact areas can be allowed to have even 7-8% capital with no effect to financial stability.

Most Indian banks, very small in size are way behind the 30 global banks in eleven capitals in the world. Their assets-to-GDP ratio is more than 200 per cent. In contrast, India’s big banks — ICICI and SBI — have combined assets of just over one-fifth of the country’s GDP. Riskiness of assets in Indian banks arises more from the quality of lending than from the vanilla products and off-balance sheet exposures and assorted amorphous financial products. In the backdrop of Basel III, the RBI in a report in 2012 indicated the capital requirement for Indian banks could be around Rs.5trillion by March 2019. In the past 15 years, the Union Government, as owner of PSBs infused capital of the order of Rs.81bn in PSBs. It makes lot of sense to provide capital regulations independent of Basel and yet operate in a globally secure financial environment.

Local Necessity:

NPAs, which is now shown as raison de etre for the demand on the capital will be usually responded through provisioning in Profit and Loss Account. A provision in P&L account would lead to issuing fewer dividends on the capital and therefore the shareholders’ interests suffer. Bank Capital becomes less attractive for investors.  Reduction of NPAs would happen only through quality of lending and supervision of assets coupled with eternal vigil by the Board of Directors of banks. Refurbishing capital with the rise in NPAs would only incentivize the poor quality of lending.

It makes lot of sense to improve the insurance and guarantee mechanisms to take care of the asset failures in the farm and MSME sectors caused more by vagaries of nature than man. Bank Boards would do well to make a qualified assessment of failures and write off the bad loans in these sectors rather than perpetuating a defective loan book. In the worst case, the Government could write off such loans through fiscal route than monetary route would make the banks stronger and protect equity and discipline in banking.

Further capital infusion should be conditioned by demonstrated better performance of PSBs concerned and the effectiveness of the Bank Boards in improving the quality, direction and quantity of overall credit portfolio of banks. Globally reputed rating institutions seem to be providing rating of Indian banks based more on the way the wind is blowing than on the fundamentals and applying equal parameters with those of the globally placed institutions. For example, when the US banks do not conform to Basel capital norms same as those of Indian banks, how could they get better rating than the Indian Banks? Therefore it is desirable and necessary that the RBI should rate the Indian banks on certain transparent parameters and advise the government me need for any further capital infusion. Second, it is equally important that the government should mandate that the additional capital should be leveraged for better loaning in the strategic sectors of the economy – agriculture and MSMEs.

K.J. Udheshi, a Member of the Financial Sector Legislative Reforms Committee, receiving the MR Pai Memorial Award of All India Depositors’ Association during September 2015, advised complete disinvestment of Union Government’s share holding in the PSBs; setting up a Resolution Corporation in the place of DICGC and allowing the weak banks to die a natural death as the most needed set of reforms to pep up growth to provide critical balancing of infrastructure debt funding through the PSBs.

But if such disinvestment is done through LIC picking up the stock it would be a sure shot for a disaster in the waiting. LIC’s average holding in the banking sector is around 9%, and in at least 15 public sector banks it is more that 10%. LIC holds 15% stake in Bank of India and Canara Bank and 22.5% in Corporation Bank.

Releasing the Annual Report of RBI on August 27, 2015, Raghuram Rajan mentioned. “Reforms cannot be shots in the dark, subjecting the economy to great uncertainty and risk,” He also wrote: “Wherever possible, we have to move steadily but firmly, ever expanding the scope of reforms, while always limiting the uncertainty they create. But reforms do not mean the recapitalization drive by the government so much as divestment of capital and to a degree even ownership of banks.  – Article published in ‘The Q-factor –BFIS, October 2015.pdf’‘