The re-imposition of lockdown
in various parts of the country to contain the spread of Covid-19 will affect the normalisation of economic activity and increase uncertainty. A gradual recovery will directly affect the ability of borrowers to repay debt. As a result, non-performing assets
(NPAs) in the banking system are bound to go up in the coming quarters. According to the financial results for the January-March quarter, the situation in the banking sector improved somewhat, but there was still considerable stress, especially in the public sector banks (PSBs). For instance, PSBs, as a group, set aside over Rs 50,000 crore during the quarter and showed a net loss of over Rs 7,700 crore. Private sector banks, on the other hand, made provisioning worth over Rs 32,000 crore, which was lower than in the December quarter and reported a net profit of about Rs 12,000 crore. Gross NPAs in most of the PSBs were in double digits. As the asset quality is likely to take a hit in the coming quarters, banks would need to build capital buffers to be able to absorb the potential shock, especially once the loan moratorium comes to an end.
However, there is a clear divergence in the way private sector banks
and PSBs are approaching the issue. While the private banks are busy raising capital, PSBs are lagging. The biggest reason for this could be fiscal constraints and the inability of the government to provide capital for PSBs from the Budget. The government, of course, has the option of using recapitalisation bonds. They will not push up the fiscal deficit, but add to the overall debt stock. Since the capital requirement is likely to be large in the coming quarters, to what extent the government would be willing to throw money at these banks remains to be seen. But it may not have too many options. Further consolidation is unlikely to work. Mergers are problematic because the banks will be occupied for the next couple of years with internal merger issues and lose ground in the credit market in the interregnum. The government also cannot privatise these banks in the present circumstances. Besides political opposition, privatisation would be difficult because of low valuations, and lead to all kinds of allegations. On average, PSBs are trading at about 0.6 times the book value. Also, there may not be too many contenders for PSBs in this market.
Further, while there is renewed discussion on allowing industrial houses to own banks, the idea should be avoided. A merger of industrial and financial capital would be dangerous, given the standards of corporate governance in India. Thus, the government doesn’t seem to have an optimal solution for PSBs. Although the pandemic would significantly increase difficulties in the coming quarters, problems in PSBs are more fundamental and largely the government’s own making. It never pushed the required reforms in PSBs to improve their operational capabilities. As a result, PSBs continue to underperform and are rapidly losing market share to the private sector. Since the system is still dominated by PSBs, stress in their balance sheets will affect the flow of credit to the productive sectors of the economy and impede a sustainable recovery from the pandemic shock.