Syllabus: GS-II, III and Essay
The Indian Banking System has been under severe stress due to NPAs and has faced a capital crunch forcing it to curtail lending. Due to this, the Government of India has announced a ₹2.11 trillion bank recapitalisation plan for state-owned lenders weighed down by bad loans, seeking to stimulate the flow of credit to boost private investment. The plan has the following components – ₹1.35 trillion from the sale of recapitalisation bonds and the remaining ₹76,000 crore through budgetary allocation and fundraising from the markets.
Why do banks need recapitalisation?
To understand this, one must examine the way banks loan money. The banks create loans based on the amount of capital in hand. Taking an example, let us say that a bank has forwarded loans of ₹100cr. To back this loan, the bank must have at least 10% of the loan amount as capital i.e. ₹10cr. Now suppose, the bank loses ₹5cr on the loans due to a defaulter, it turns the loan into a non-performing asset (NPA) and this loss hits the capital.
Now, the bank has ₹5cr (₹10cr-₹5cr loss) capital against a loan of ₹95cr which comes out to be nearly 5 %. This is way below the required 10% ratio. So, the bank needs to increase its capital ratio and this can be achieved by the following methods:
- Recall loans worth ₹45cr so that the remaining loans to capital ratio now increases to 10%.
- Freeze disbursement of loans
The banks have resorted to the latter as loan recall is not a viable option. This has adversely affected the economic growth of the country as a credit crunch has reduced private investment and stressed corporate balance sheets further. The. ‘twin-balance sheet’ problem has thus been exacerbated.
What is the status of NPAs in the country?
The banking sector in India has been significantly hit by stressed and non-performing assets. According to the figures released in June-end 2017, eight public sector banks have gross NPA ratios (GNPA) over 15%.
Among the top 20 banks, 18 are PSBs and only two are private sector banks. SBI, Punjab National Bank, Bank of India, IDBI Bank, and Bank of Baroda accounted for 47.4 percent (₹3,93,154 crore) in the total NPAs.
State Bank of India (SBI) itself accounted for the largest share of about 22.7 percent (₹1,88,068 crore) in the total NPAs of 38 banks (₹8,29,338 crore).
SBI is also a domestic systemically important bank (D-SIB) as categorised by the Reserve Bank of India. Since the situation has reached crisis levels in the public sector banking system, it is imperative that the government inject capital to sustain the functioning of these banks.
Why has there been a growth in NPAs?
Though the problem was identified two years ago, it continues to grow due to the following reasons:
1. Due to over-leveraged balance sheets of corporates that borrowed liberally during the economic boom and are now unable to pay back.
2. Delay in permissions and various clearances has led to stalling of projects. This is true for large infrastructure projects.
3. Faulty reporting mechanisms of banks, this has led to the NPA problem worsening before the NPA accounts were verified accurately. This was rectified during a detailed Asset Quality Review (AQR) by the Reserve Bank.
4. There have been instances of wilful defaulting and a nexus between bankers and corporates has increased this problem
What measures has the government taken to recapitalise banks?
1. Indradhanush Scheme – the Government had announced to infuse Rs70,000 crore in state-run banks over four years while they will have to raise a further Rs1.1 trillion from the markets to meet their capital requirement in line with global risk norms, known as Basel-III. In line with the plan, public sector banks were given Rs25,000 crore in 2015-16, and similar amount has been earmarked for the current fiscal. Besides, Rs10,000 crore each would be infused in 2017-18 and 2018-19.
2. Recapitalization with Rs.2.11 trillion using recapitalisation bonds, budgetary allocation and funds raised from the market. This decision was taken after the Asset Quality Review conducted by the Reserve Bank.
3. Using funds from the National Investment Fund. This fund is constituted from the sale of the stake in public sector enterprises I.e. disinvestment.
What are the concerns regarding recapitalisation?
1. The increased budgetary allocation will cause the government to breach its fiscal deficit targets. Such a move will hurt economic growth and investor confidence in the Indian economy.
2. There is a concern that recapitalisation only addresses the symptom and not the root of the problem of NPAs. Thus, without complementary measures (as suggested under Indradhanush scheme) it becomes a political tool like the farm loan waivers.
3. The ethical concern that poor decisions of the public sector banks will be backed by the money of hardworking taxpayers is a cause of worry for the general public.
4. There can be an increase in NPAs as companies will be more tempted to default due to writing off of loans by banks.
5. Recapitalisation does not directly address the quality of lending and the cycle of bad lending could go on without other adequate measures such as reforms in the management of banks.
The decision of the Government to recapitalise banks is welcome as it will not only help in cleaning up of balance sheets but also help boost private investment in the economy. However, it also raises the issue of breaching the fiscal deficit target where the government may itself turn into the largest borrower and crowd out private borrowing as well as the bond market. Also, without other measures mentioned under the Indradhanush scheme, the recapitalisation of banks may turn out to be a temporary relief rather than a solution. Thus, it is required that all resolution measures be taken together promptly for an improvement in the Indian banking system.
Non-Performing Asset (NPA)
A nonperforming asset (NPA) refers to a classification for loans on the books of financial institutions that are in default or are in arrears on scheduled payments of principal or interest. In most cases, debt is classified as nonperforming when loan payments have not been made for a period of 90 days.
Asset Quality Review (AQR)
An asset qualityreview is the evaluation assessing the credit risk associated with a particular asset. These assets include loans and investment portfolios.
Basel III Norms
Basel guidelines refer to broad supervisory standards formulated by Basel Committee on Banking Supervision (BCBS). From this, three norms have come which are of voluntary nature. The Basel III norms specify a certain level of capital, leveraging, funding and liquidity for banks. These were released in the aftermath of the Global Financial crisis of 2008. These norms are to be implemented by 2019.
Mission Indradhanush is a seven-pronged strategy of the Government of India to resolve various issues faced by Public Sector banks (PSBs). It aims to entirely reform their structure and functioning. The seven parts are -Appointments, Banks board bureau, Capitalisation, De-stressing, Empowerment, Framework of accountability and Governance reforms.
Domestic Systemically Important Bank (D-SIB)
D-SIB means that the bank is ‘too big to fail’(TBTF). According to the RBI, some banks become systemically important due to their size, cross-jurisdictional activities, complexity and lack of substitute and interconnection. Banks whose assets exceed 2% of GDP are considered part of this group. If such a bank fails, there would be a significant impact on the overall economy.
|Who||Public Sector Banks by Government of India|
|Why||• To meet capital requirements for Basel III norms
• To improve private investment.
• To tackle menace of NPAs
|How||• ₹2.11 trillion infusion via recapitalisation bonds, budgetary allocation and market raised funds
• Indradhanush scheme
• Disinvestment proceeds from CPSEs