Is recapitalisation a solution for NPA stress of Indian banks?

Indian banking sector is under severe stress with extremely high levels of Non Performing Assets. To tackle this problem, bank recapitalisation has been touted as a solution. To what extent can recapitalisation of banks help? What other measures can be taken to improve the health of the Indian banking system? Discuss.

The government has recently announced a relief package of ₹2.11 lakh crore for recapitalisation of public sector banks. The move is expected to help the banks in several ways:

  • The infused capital could give the banking system a good breathing time to enhance its credit portfolio and restore value out of the NPA accounts.
  • During this time, the regulator, banks and the government can focus on the quality of public sector banking assets, the NPAs and the recovery.
  • It can prevent further drop in economic value of the banking sector. Today’s ₹8 lakh crore problem might grow into a much larger amount tomorrow.

However, there are some apprehensions about the aforementioned benefits of bank recapitalisation for the following reasons:

  • The idea of recapitalisation rests on the fact that the Insolvency and Bankruptcy Code (IBC) reform has not yielded satisfactory results. In fact, it is feared that the proceedings can actually help the defaulters retain their company at a lesser cost. This is possible because the defaulters are allowed to bid for their own companies. This loophole may cause banks to lose huge amounts. Until the bankruptcy process becomes profitable for the banks, the banks’ risk eroding their capital. Lack of adequate capital prevents banks from lending which eventually dampens the economy. Hence, to bolster the economy, recapitalisation is the only way out for the moment.
  • In the last three years, banks have written off about ₹ 2 lakh crore. When banks lose money or when the government recapitalise PSBs, it is the people’s money that is being used to fund corporate default.

Way forward:

It is the fourth time since the mid-eighties that PSBs are being infused with substantial capital due to high NPAs (15-20 %). Since it has become a repeated phenomenon, it is important to understand that recapitalisation is only a temporary solution that treats symptoms and not the underlying cause of the problem. Government should take certain other measures to ensure that the need for recapitalisation doesn’t arise again and again. Some of the measures are stated below:

  • There has been a demand for the publication of names of defaulters and to declare wilful default as a criminal offence. The government should ensure that it happens soon.
  • As long as the government wants to hold on to 51% equity in PSBs periodic injection (like Indradhanush) by way of recap bonds will prove to be unsustainable. To fund the economy, the government will have to make yearly budgetary allocation of the amount of capital required by PSBs.
  • The governance and regulatory framework of the banks should also be modified. For improving governance of PSBs, questions like the tenure of senior management have to be addressed as was also recommended by the Narasimhan Committee of 1991 and 1998. Public Sector Bank chiefs and their managing/executive directors must have a fixed tenure of at least five years. The second issue is the salary structure of senior management. To offer incentives, good annual bonus based on performance should enable right decision making. There is also a need to remove unnecessary political and economic influence on the decision makers.
  • Another issue is of professionalisation through lateral entry which should be at the level of general managers and not at the ED/MD level. Also, the banking boards need to be manned by professional directors rather than political nominees.
  • Accountability needs to be fixed by removing senior management for non-performance.
  • There are a few gaps in the regulatory framework as well. One of them is joint lending. Borrowers borrow from different banks. Banks do not talk to each other. The absence of a joint dialogue also leaves large projects deprived of the needed capital. This proves uneconomical, costly and leads to corrupt practices as bank officials seek favours to agree to a proposal. Thus, there is a need to adopt some best practices by creating a framework for joint funding of projects.
  • Another issue is the appointment of statutory auditors. In the best private sector companies, the auditors are shortlisted by promoters and then assessed by the Audit Committee and Board. Also, in case of wrong reporting, these have to be punished by at least prohibiting them to audit any financial entity regulated by the RBI, the Securities and Exchange Board of India, the Insurance Regulatory and Development Authority and the Pension Fund Regulatory and Development Authority. A similar model is urgently needed for the banking sector.
  • And last, action must be taken against promoters who have siphoned off funds and transferred them to their personal assets. These assets must be forfeited and the RBI needs to move ahead on that.
  • To fix NPAs, in addition to the resolution of the above issues, a quick action plan is needed. First, NPA cases caused by the cyclical nature of the sector need to be supported if there are no issues with fund utilisation.
  • Also, we need to deal with NPAs sector by sector (like power, roads, steel and so forth). We need to pick NPAs from PSBs of each sector, park them in one place by creating an entity like a SUUTI (specified undertaking of the Unit Trust of India), fund the banks and invite international and national investors to dispose of the assets.

Conclusion:

The capital infusion is a welcome step but there are issues that should be dealt with first. This capital can improve government’s equity to 70-80% in each PSB. However, much more needs to be done which alone would ensure that the recapitalisation yields desirable results. For the government to make profits by selling this equity, it is imperative to undertake substantial and long-term measures.