Apart from implementing a new Insolvency and Bankruptcy Code (IBC), which allows for quick resolution and gives creditors teeth to seize assets, the government announced a massive recapitalisation plan. This should shore up net worth of PSBs by Rs 2.2 lakh crore if it all works out.
The recapitalisation plan envisages tapping the market for about Rs 58,000 crore of fresh equity (while the government will subscribe Rs 17,000 crore) and issuing recapitalisation bonds for over Rs 1.4 lakh crore. Those bonds will be subscribed to by the banks themselves, cleverly transferring deposits (liabilities) to Tier-1 Capital since government bonds are by definition, 100 per cent safe.
Unfortunately, this might not be enough. The latest news on NPAs suggests PSBs might require twice this amount to be fully recapitalised to meet Basel III norms. What’s more, NPAs are still rising, although at a slower pace.
The latest Financial Stability Report from the RBI suggests gross NPAs will continue to rise, hitting about 11 per cent of total banking assets by September next year. That works out to about 6.5-7 per cent of the gross domestic product (GDP). Stressed assets (this includes restructured loans, which have a high chance of going NPA) are likely to peak at above 12.5 per cent.
A further cause for concern is private sector banks have also been affected to a greater degree than previously realised. The gross NPAs for these banks are now at 3.8 per cent.
There’s been a 40 per cent jump in private sector NPAs, though this may be due to enforced recognition. Private banks have been punished for under-reporting.
Given the Basel III timeline, as set by the RBI, is March 2019, the need to clean this up and recapitalise is pretty urgent.
The added complication is that this is an election year when there will be huge political pressure on government banks to forgive loans and to make more loans without proper due diligence.
There are many implications. The PSU recap should release funds for commercial credit — PSBs are flush with funds (post-demonetisation) but need the net worth shored up. There will be bank equity sales through 2018-19, for sure.
These could be rights issues, or follow-on public offers. But, if PSBs alone mop up Rs 58,000 crore and private banks also tap the market, other sectors may be crowded out.
Private bank valuations may fall if the market is concerned by the rising NPA profile and equity expansions. Equity expansions will mean more liquidity but also lower earnings and lower book value.