Why Jaitley's big bank bailout will remain a half-measure without focus on bad loans
Because of the rising NPA problem, the only way the PSU banks could stay solvent was by not lending altogether.
On October 24, Union finance minister Arun Jaitley made the big announcement that public sector banks in India would be given a fresh lease of life by injecting them with Rs 2.11 lakh crore - about Rs 1.35 lakh crore in recapitalisation bonds and Rs 76,000 crore through existing budgetary allocations and from the market.
This move - being hailed as the big PSU bank recapitalisation, or approached cautiously as the big bank bailout - is expected to revitalise the sagging PSU banking sector, which had almost stopped lending because of the massive aggregation of corporate debts that have not been recovered.
PSU banks are sitting on NPAs and stressed assets worth Rs 10 lakh crore, of which almost 70 per cent is from a handful of 50 major corporate behemoths.
Therefore, while the government is unwilling to label these corporates as "willful defaulters", thereby not allowing aggressive recovery of the loans through punitive means, it is nevertheless trying to spur the investment climate and allow more lending from the PSU banks by giving them an additional Rs 2.11 trillion, so that their balance sheets look better. In banking parlance, this is called improving the banks' capital, and it's absolutely central to a healthy banking sector, the cardiovascular system of the country's economy, with the RBI as its heart.
The banks, particularly the public sector banks, lend to the smaller and medium entrepreneurs, and are therefore integral in ensuring that the money is more evenly distributed, that the smaller guys get credit to pursue businesses that collectively make the India story. So, the government reinjecting Rs 2.11 trillion into the PSUs should ideally be a good thing. But that's not the whole story. However, let's first look at why this was nevertheless much needed.
Much needed measure
The bank recapitalisation would help the "genuine borrowers" - those with good credit history, who return with interest what they borrow and don't default and keep the banking sector going - get funding from PSU banks. Because of the rising NPA problem, while there was no recovery of the bad debts, the only way the banks could stay solvent was by not lending altogether. In fact, the problem had become so acute that private banks and non-banking financial companies (NBFCs) were responsible for lending almost 65 per cent of the total lending by March 2017, as the market value and the capital base of the PSU banks had fallen drastically, by 50 per cent according to some estimates.
Without adequate capital - most of which was held up in the NPAs of the big defaulters - the PSU banks simply could not extend more credit even to the credible borrowers. This meant the public banking sector was very, very ill, and needed its medicine - fresh inflow of capital. This is what the bank recapitalisation - via bonds and raising money from the market, existing budgetary allocation - would do. The government says, and it's partially correct, that this would spur growth, revitalise the lending scene, and therefore revive the economy to put it on track to recovery. It will help entrepreneurship, the Modi government's hallmark of a buoyant economy.
What about the NPAs?
Because the government is the biggest shareholder of the public sector banks, about 22 big ones that form 71 per cent of the Indian banking sector, the PSU banks are the lifeblood of the economy. But what's weighing them down is the albatross of non-performing and stressed assets worth Rs 10 trillion, or even Rs 13-14 trillion, according to recent figures. Now, FM Arun Jaitley himself has admitted, a congregation of 50 big defaulters, who were given massive loans indiscriminately by PSU banks, form over 80 per cent of the NPAs. While the government made a big song and dance about catching the "King of Good Times" Vijya Mallya for his Rs 8,000 crore willful default on loans, he's really a small fry when compared to the amount we are staring at.
While the RBI has "identified" the big defaulters, it's not yet ready to come out in public with the list, which is basically giving them more time to keep adding to the bad loan problem, if not writing them off.
Although FM Jaitley doesn't agree about the technicalities, reports on the banks writing off bad loans worth Rs 2.2 trillion in five years have already done the rounds earlier this year. As many as 27 PSU banks, including the SBI and its five associates, in 2016-17 alone have written off bad loans worth Rs 81,683 crore, 41 per cent higher than the previous fiscal year.
As a result, the NPAs too have increased, almost doubling in the last three years of Modi government, and now they form 9 per cent of the net bank credit from about 4 per cent in 2014. Doesn't this fly in the face of efficient economics? Why is the government writing off loans worth the same amount or more when it makes a grand show of injecting capital into the PSU banks? Short answer: the economics of politics.
The demonetisation dud
Many experts batting for the demonetisation diktat of November 8, 2016 had expected the move to extinguish black money worth Rs 3 lakh crore. When 99 per cent of the demonetised currency came back to the banking system, it was proven that was not the case.
Most likely, the black money had returned to the system as white, or people simply didn't have black money in cash. Either way, the surplus that the government had earmarked for possible bank recapitalisation never surfaced from note-bandi, making it a fruitless strain on the Indian public and a major lag on the economy, taking its growth rate down by 2 percentage points from 7.9 in second quarter 2016 to 5.7 one year later.
What about banking reforms?
The recapitalisation bonds are a clever sleight of hand, though completely legal, whereby government issues bonds which the banks buy. The banks give money to government - their biggest promoter - to turn around and buy shares from these very banks, thereby making them flush with new capital.
Though it can be seen as a kind of financial jugglery, unless actively followed up by credit discipline and loan recovery from corporate defaulters, this is an inadequate intervention. It's extremely important to strike at the heart of the beast that is the NPA, something former RBI governor Raghuram Rajan had pointed out many times over. Without lending discipline and bad loan recovery, the fiscal stimulus in the form of bank bailout actually increases the possibility for NPAs rising in future.
If the big corporates think that the government is not really after them, and if we keep lapping up the periodical song and dance about the posterboy of corruption Mallya making a ritual court appearance in London, then no recapitalisation of the banks can actually help Indian economy in the medium and long term.