Will bank recapitalisation succeed? 

Call it India's version of TARP—the troubled asset relief program the U.S. introduced after the 2008 mortgage crisis. But has India’s public sector bank recapitalisation programme come at the right time? Or has the Narendra Modi government missed the bus on banking reforms? Opinions are divided.

The recapitalisation programme, worth Rs 2,11,000 crore, was first announced in October, 2017. Back then, the government had spelt out only the basics about the plan. It announced that Rs 1,35,000 crore would be infused through recapitalisation bonds, which would be issued by the government and would be subscribed by public sector banks in lieu of the capital they get from the government. Additionally, Rs 18,000 crore is proposed to come from budgetary allocation and the balance Rs 58,000 crore would be raised by the banks through capital markets.

On Wednesday, days before the Union Budget for 2018-19 is to be presented in the Lok Sabha by finance minister Arun Jaitley, his office made public the details of the bank recapitalisation programme.

In the current financial year, Rs 88,139 crore would be infused into the banks, of which Rs 80,000 crore would be from recapitalisation bonds and Rs 8,139 crore would be from budgetary allocation. But the programme goes beyond infusion of money as the ministry informed that the recapitalisation will be ‘accompanied’ with reforms at public sector banks.

For instance, all loans above Rs 250 crore would be scrutinised by specialised monitoring agencies. Further, each public sector bank will be required to have a stressed asset management vertical to ensure stringent recovery follow-up.

“We have been focused on finding a solution to the problems of the past,” said Jaitley while announcing the reform and recapitalisation plan.

Yet, not everyone is convinced that these measures are enough.

Out of the 21 public sector banks, 11 are under the Reserve Bank of India’s prompt corrective action (PCA) framework—banks with high levels of non-performing assets and consecutive years of losses. Recapitalisation of banks under the PCA framework will allow them to reduce the NPAs as well as improve capital ratios. But as many public sector banks are likely to continue reporting losses during FY18 due to elevated provisioning levels, they are likely to remain under PCA based on the 2017-18 financials. This would continue till the banks turn profitable, says rating agency ICRA.

According to ICRA’s estimates the current capital allocation is based on the capital ratios and the NPA levels of individual banks and ability of these banks to absorb credit losses from their operations. Certain banks have received much higher capital in relation to the March 31, 2018 regulatory requirements, which possibly reflects the likelihood of much higher credit provisioning these banks will require on their NPAs during the second half of 2017-18.

Anil Gupta, ICRA’s sector head for financial sector ratings estimates that the recapitalisation will be equivalent to 1.5% of the risk weighted assets (RWA) of the bank(s). “However the capital ratios of the bank(s) is unlikely to improve by an equivalent amount as a portion of this capital will be off-setted against the losses because of elevated credit provisions the banks will be required to make,” says Gupta. While the current capital allocation is higher for weaker banks, the next round of recapitalisation (Rs 64,861 crore in 2018-19) could be based on the performance of the banks, with stronger banks receiving higher share of capital, opines Gupta.

Welcoming the government’s capital infusing decision and reiterating its commitment to support all the public sector banks to meet regulatory capital ratios, Karthik Srinivasan, ICRA’s group head for financial sector ratings expects “the capital infusion plans to be sufficient for most of the public sector banks to meet the regulatory capital ratios under Basel III regulations”.

However, some believe that the recapitalisation is not much different from throwing good resources behind bad assets. Nilanjan Karfa and Harshit Toshniwal, equity analysts at Jefferies India Pvt Ltd are close to endorsing the view as they say, “it is broadly implied that the infusion of capital in PCA banks is to provide them enough oxygen to survive/revive and growth capital for non-PCA banks.”

Calling the move as quantum of no solace, the duo highlights that banks that are under corrective treatment receive around 58% of their combined market capitalisation, or 14% of the gross stress, while the better set of banks receive the balance 8.3% of their market capitalisation, and 7.1% of gross stress. “This is in contrast to market expectations of bigger/healthier banks receiving a higher share of capital,” the duo adds.

But not all analysts hold the same opinion. Nomura calls the plan a “game-changer”, whereas Morgan Stanley calls it a good allocation of capital as it provides higher amounts of capital to banks with weaker capital and profitability. “This should allow these banks to make proper provisions on their bad loans, helping to clear system asset quality,” says a Morgan Stanley report. “Small banks could do well in the near term, given the quantum of capital; however, returning to normalised return on equity will probably take a long time,” the report warns.

Another challenge for banks is the new accounting standards (Ind-AS 109) which could come into effect from the fiscal beginning April 1, 2018. India Ratings and Research, the Indian outfit of Fitch Ratings group, estimates that scheduled commercial banks may need up to Rs 89,000 crore towards incremental provisioning for advances while transiting to the Ind-AS 109 regime.

Of this, public sector banks would need Rs 63,100 crore. “Assuming Ind-AS is implemented from 1 April 2018, close to 41% of announced recapitalisation funds would be consumed towards incremental provisioning requirements, putting pressure on public sector banks’ ability to meet the regulatory core equity tier 1 capital under Basel III framework,” says Udit Kariwal, senior analyst at India Ratings and Research in a report.

Additionally, Kariwala adds that India Ratings and Research believes public sector banks’ capital consumption to remain high, given that profit and loss accounts for most of banks (especially the mid-size banks) would remain under pressure due to the accelerated provisioning requirement on the accounts identified by the regulator for reference to the National Company Law Tribunal under the Insolvency and Bankruptcy Code in the 2017-18 financial year.

The quantum of the government’s proposed capital injection, together with the banks’ proposed mobilisation of capital, should largely cover the provisioning shortfall for their stressed assets. “The capital can also support modest growth (around 7%) in advances,” says Kariwala. Additional equity would be required if the credit demand were to pick up.

The way forward is challenging for public sector banks. But, the finance minister will have lesser worries in the ensuing budget as far as state-owned banks go.