Mr Jaitley, Until When Will Govt Continue To Support Public Sector Banks?

Fostering Public Leadership - World Economic Forum - India Economic Summit 2010
The Economic Survey released on February 26 had a very interesting number in it. It pointed out that between 2009-2010 and the first half this financial year, the government had infused a capital of Rs 1.02 lakh crore into public sector banks.

And it ain’t done with it as yet. As finance minister Arun Jaitley said in his budget speech earlier today: “We are now confronted with the problem of stressed assets in Public Sector Banks, which is a legacy from the past. Several steps have already been taken in this regard…To support the Banks in these efforts as well as to support credit growth, I have proposed an allocation of Rs 25,000 crore in 2016-17 towards recapitalisation of Public Sector Banks. If additional capital is required by these Banks, we will find the resources for doing so. We stand solidly behind these Banks.

This means that the government will continue to pour money into public sector banks. Jaitley has clearly said that the government will invest as much money as it takes in order to recapitalize public sector banks.

The stressed loans of public sector banks as on September 30, 2015, stood at 14.2% of the total loans. Hence, for every Rs 100 of loans given by public sector banks, Rs 14.2 has either been declared to be a bad loan or has been restructured. In March 2015, the stressed assets were at 13.15%.

A restructured loan essentially implies that the borrower has been given a moratorium during which he does not have to repay the principal amount. In some cases, even the interest need not be paid. In some other cases, the tenure of the loan has been increased.

Further, the public sector banks have been under-declaring their level of bad loans by restructuring loans and kicking the can down the road. Nearly 40% of the restructured loans have gone bad over the last two to three years. This means many restructured assets will continue to go bad in the years to come.

With bad loans and restructured assets accumulating the public sector banks will continue to need fresh infusion of capital. Also, estimates made by the PJ Nayak Committee suggests that between January 2014 and March 2018 “public sector banks would need Rs. 5.87 lakh crores of tier-I capital.” The committee further said that: “assuming that the Government puts in 60 per cent (though it will be challenging to raise the remaining 40 per cent from the capital markets), the Government would need to invest over Rs. 3.50 lakh crores.”

The government on the other hand estimates that “the capital requirement of extra capital for the next four years up to FY 2019 is likely to be about Rs.1,80,000 crore.”

Both the estimates are very large and have the potential of really screwing up the fiscal deficit number of the government in the years to come. Fiscal deficit is the difference between what a government earns and what it spends.

This is a clear impact of the government continuing to own 27 public sector banks. Narendra Modi in the run up to the 2014 Lok Sabha elections had promised “minimum government maximum governance”. This promise has clearly gone out of the window. It is visible in the fact that the government continues to own so many public sector banks.

The tendency in the government is to look at shares of public sector companies as family silver. And given the bad state of the stock market currently, this family silver cannot be sold.

But the trouble is that any government can only do so much. And given the problems that the Indian economy is currently facing, this government is clearly overextending itself in trying to save each and every public sector bank.

Jaitley also taked about operationalising the Bank Bureau Board in 2016-2017. This Bureau expected to search and select heads, wholetime directors and non-executive chairmen of public sector banks. The idea is to professionalise the public sector banks.

Jaitley further said: “The process of transformation of IDBI Bank has already started. Government will take it forward and also consider the option of reducing its stake to below 50%.” Does this mean privatisation of IDBI Bank? It doesn’t seem like that.

Recently, IDBI Bank made public, plans of raising Rs 1500 crore from the Life Insurance Corporation(LIC) of India. LIC currently owns 7.25% of the bank. With this new issue of shares, the LIC holding in the bank will increase to around 19%. If this is the route that Jaitley plans to reduce the stake of the government below 50% in IDBI Bank, then this can’t be really called privatisation. It is essentially moving money from one arm of the government to another arm, something the Congress led UPA government used to specialize in.

The moot question is why does the government need to own 27 public sector banks? It’s social sector obligations can easily be fulfilled by continuing to own SBI and a few other banks, depending on which bank is strong in which part of the country.

In his speech Jaitley also talked about bringing a comprehensive legislation for tackling the Ponzi scheme menace, though he did not use the word Ponzi anywhere. It is difficult to comment on this right now given that no details are known. Nevertheless, it will be interesting to see how different this new legislation will be from the ones already in place and whether it will actually lead to the number of Ponzi scheme launches coming down.

Jaitley also talked about the government facilitating the deepening of corporate bond market, in his speech. This is something several finance ministers have talked about in the past. He also talked about amending the RBI Act 1934 to provide a statutory basis for Monetary Policy Committee. Once the Committee is in place the decisions on repo rate changes will be made by the Committee, instead of just the RBI Governor, as is currently the case.

(Vivek Kaul is the author of the Easy Money trilogy. He tweets @kaul_vivek)

The column originally appeared on SwarajyaMag on February 29, 2016

One last time: The govt shouldn’t be running 27 banks

In yesterday’s edition of The Daily Reckoning
I explained why the privatisation of IDBI Bank is a test case for the Narendra Modi government.

The other important point that I made in the column (and have made in the past) and will make again today is that there is no reason the Modi government (or for that matter any other) should be running 27 public sector banks.

Let me first explain why I am making this point again today. Yesterday’s edition of The Times of India had a news-report headlined “Govt looks at 3 options to reduce stake in IDBI Bank“. This news-report talks about the three options the government is looking at in order bring down its stake in IDBI Bank.

While a decision on how the shares of IDBI Bank will be disinvested hasn’t been made, the three ways the government is looking at are: a) to sell the shares in small lots to the public through the stock exchanges. The trouble with this option is that the government may not be able to sell the shares at the best possible price.

b)The second option being considered is to sell the IDBI Bank shares to the likes of Life Insurance Corporation (LIC) of India, other government owned insurance companies and pension and provident funds, at a premium to the current market price. This option, as has often been the case in the past, is taking the easy way out.

c) The third option (which is very similar to the second option) being considered is to sell shares to public sector banks and financial institutions. This was tried in the case of Maruti Suzuki in 2005-2006. A PTI news-report published on January 12, 2006 points out: “The government today sold 8% shares in MarutiUdyog for Rs 1,567.60 crore with Life Insurance Corporation (LIC) picking up more than 50% of the 2,31,12,804 shares sold by the government. LIC successfully bid for 1,68,00,000 shares at Rs 682 per share. Eight public financial institutions have picked up Maruti shares. SBI would be getting 39,27,074 shares at Rs 660 per share.”

None of these methods will lead to genuine privatisation. If the government sells shares to the general public through the stock exchanges, it will continue to remain the majority owner of shares in the bank. And that is the basic problem. As I had pointed out in yesterday’s column, the private sector banks are much better run and more profitable than their public sector counterparts.

Currently, the government owns 76.5% of the IDBI Bank. Even if it were to reduce its shareholding to 49%, it will still continue to be the biggest shareholder in the bank. With government ownership comes political corruption, crony capitalism and bad lending, which leads to bad loans. This story has played out over the last few years.

In fact, the net non-performing assets of public sector banks, for the financial year ending on March 31, 2015, stood at 2.92% of their total advances (i.e. loans). It was at 2.01% for the financial year ended March 31, 2013. In comparison, the private sector banks are extremely well placed with their net non-performing assets being at 0.89% of their total advances. For financial year ending on March 31, 2013, the net non-performing assets of these banks stood at 0.52%.

What this clearly tells us is that the private sector banks are better at lending money given that they don’t have to deal with political corruption and crony capitalism. In a poor country like India it is important that any money that is being lent is utilized properly as far as possible and is not siphoned off by greedy businessmen. It has become clear over the last few years that businessmen find it easy to siphon off money they have borrowed from public sector banks in comparison to private sector banks.

The second option being considered by the government is to sell shares to LIC. The interesting thing is that LIC already owns 8.59% of the bank. Does it make sense to allow LIC’s investment in any stock to go beyond 10%? The Securities and Exchange Board of India does not allow mutual funds to own more than 10% of a company. This is to prevent concentration of risk on the overall investment portfolio. But this does not apply to LIC, given that it is an insurance company.

The question is why is the government allowing this concentration of risk in LIC’s investment portfolio to happen? Ultimately like mutual funds, LIC is also basically managing money.

Further, it is also important to state here that the money that LIC has is not government’s money. LIC manages the hard earned savings of the people of India and given that these savings need to be treated with a little more respect.

Also, selling shares to LIC or the State Bank of India, for that matter, means that the ownership stays with the government. And that as I have stated earlier, is the basic problem. For IDBI Bank to do well, it needs genuine privatisation with a private owner, with the government being a minority shareholder at best.

As I had mentioned in yesterday’s column, IDBI Bank is saddled with a huge amount of bad loans. And given this it is not surprising that the government owned financial institutions are not keen on picking up any stake in the bank.

The Times of India news-report cited at the beginning points out: “State-run entities are, however, not very keen on buying the government stake. “Given the distress in the banking sector, IDBI Bank may not be the best bet since its retail as set base is weak and it has legacy issues,” said a top official.”

IDBI Bank was a major lender to Kingfisher. It also lent to Deccan Chronicle Holdings, Bhushan Steel and Jaypee Associaties, companies which are in a financial mess.

Also, if the government follows any of these three methods to sell shares in IDBI Bank, as the majority shareholder it will have to continue to keep pumping money into the bank. In fact, the government holding in the bank has gone up “from 65.14% in July 2010 to 76.5% in December 2013 by total equity infusion amounting to Rs 5,300 crore”.

Any increase in holding will bring us back to square one.

In May 2014, the Committee to Review Governance of Boards of Banks in India (better known as the PJ Nayak Committee) had submitted a detailed report on reforming the public sector banks in India.

The Nayak committee estimated that between January 2014 and March 2018 “public sector banks would need Rs. 5.87 lakh crores of tier-I capital.” The committee further said that: “assuming that the Government puts in 60 per cent (though it will be challenging to raise the remaining 40 per cent from the capital markets), the Government would need to invest over Rs. 3.50 lakh crores.”

The government on the other hand estimates that “the capital requirement of extra capital for the next four years up to FY 2019 is likely to be about Rs.1,80,000 crore.” Of this amount it proposes to invest Rs 70,000 crore. It has not explained from where will it get the remaining Rs 1,10,000 crore.

These are not small amounts that we are talking about. The tendency is to look at the government ownership in many public sector enterprises as family silver and hence, be careful while selling it. But in case of many public sector banks that cannot be really said. If the government continues to own public sector banks in the years to come it will have to keep pumping money into them in order to keep them going.

Take a look at the accompanying table. I have picked up five banks which are of a similar size. There are two private sector banks (HDFC Bank and ICICI Bank) and three public sector banks (Bank of India, Punjab National Bank and Canara Bank) in the table. The profit of the private sector banks is many times the profit made by the public sector banks. Their bad loans are also significantly lower. In fact, HDFC Bank makes more money than Bank of India, Punjab National Bank and Canara Bank put together. So does ICICI Bank.

Name of the bankTotal assets (in Rs crore)Net profit (in Rs crore)Bad loans (Net NPAs to Net Advances)
HDFC Bank5,90,50310,215.920.20%
ICICI Bank6,46,12911,175.351.61%
Bank of India6,18,6981,709.003.36%
Punjab National Bank6,03,3343,062.003.55%
Canara Bank5,48,0012,703.002.65%

Source: Indian Banks’ Association. As on March 31, 2015
To conclude, people keep reminding me that comparing the performance of public sectors banks with private sector banks is like comparing apples and oranges. The public sector banks have social obligations which private sector banks don’t. This is true. Nevertheless, the question is does the government need to own 27 banks in order to fulfil its social obligations?

I think, the government can easily go about fulfilling social-sector obligations by owning the State Bank of India and 4-5 other banks which are strong in different regions of the country.

Finally, a government should not be running so many banks. There are so many other things that it should be concentrating on, but it doesn’t.

(The column originally appeared on The Daily Reckoning on Nov 5, 2015)

Do public sector banks deserve a taxpayer bailout?

Fostering Public Leadership - World Economic Forum - India Economic Summit 2010
The finance minister
Arun Jaitley said on June 12: “Banks have made a strong case for additional capital… And over the next few months, this is something the government is going to seriously look at.” Jaitley was talking about the government owned public sector banks.
There are two questions that crop up here: a) do public sector banks deserve additional capital? b) can the government afford it? Let me first define the word capital and then answer the second question first.
As Anat Admati and Martin Hellwig write in
The Bankers’ New Clothes: “In the language of banking regulation, this word [i.e. capital] refers to the money that the bank has received from its shareholders or owners. This is to be distinguished from the money it has borrowed. Banks use both borrowed and unborrowed money to make their loans and other investments. Unborrowed money is the money that a bank has obtained from its owners if it is a private bank or from its shareholders if it is a corporation, along with any profits it has retained.”
In case of public sector banks, the government is the biggest shareholder and any capital infusion would mean the government investing more money in these banks. How much money does the government need to infuse in these banks? In a research note titled
A Growing Need for Indian TARP, Anil Agarwal, Sumeet Kariwala and Subramanian Iyer, analysts at Morgan Stanley estimate that an immediate infusion of around $15 billion (or Rs 96,000 crore assuming $1 = Rs 64) is needed in these banks. And that is clearly a lot of money for the government to spend in a single year. The budget for 2015-2016 provided Rs 11,200 crore towards fresh capital infusion by the government in public sector banks.
The PJ Nayak committee report released in May 2014, estimated that between January 2014 and March 2018 “public sector banks would need Rs. 5.87 lakh crores of tier-I capital.” The report further points out that “assuming that the Government puts in 60 per cent (though it will be challenging to raise the remaining 40 per cent from the capital markets), the Government would need to invest over Rs. 3.50 lakh crores.”
It is safe to say that the government clearly does not have the kind of money that is needed to be invested in public sector banks. Now let’s try and answer the first question which is, whether the public sector banks deserve this kind of money to be invested in them by the government.
On the face of it, the answer is yes, simply because that public sector banks carry out nearly 70% of lending in India. And if they are not adequately capitalized, they will not be able to lend as freely as they may want to and as may be needed.
But there is more to it than just that. As the Morgan Stanley analysts point out: “
The current managements’ policy of “extend and pretend” is causing banks to move further into problems.” What do they mean by extend and pretend? Crisil Research estimates that 40% of the loans restructured during 2011-2014 have become bad loans.
A restructured loan is where the borrower has been allowed easier terms to repay the loan (which also entails some loss for the bank) by increasing the tenure of the loan or lowering the interest rate. If 40% of restructured loans have gone bad, it is safe to say that the banks have been essentially restructuring loans in order to postpone recognizing them as bad loans, which is what the Morgan Stanley analysts meant by “extend and pretend”.
Interestingly, bad loans are expected to go up during this course of the year primarily because more and more restructured loans will turn into bad loans. The Morgan Stanley analysts expect nearly 65% of restructured loans to turn into bad loans.
Further, as
Crisil Research points out in a research note titled Modified Expectations: “Reported gross non performing assets[bad loans] will still remain at elevated levels as some of the assets restructured in the previous 2-3 years, especially in the infrastructure, construction, and textiles sectors, degenerate into non-performing assets again.”
Also, as Debashis Basu
points out in a column in the Business Standard, that other than an increase in bad loans, “the continued evergreening of bad accounts – and, what is worse, the continued dubious new lending by public sector banks, with minimal collateral, arranged by touts,” continues to remain a worry.
In this scenario there is no point in the government putting in more hard-earned money of taxpayers into these banks. Until, Jaitley’s statement on June 12, the government’s stand was that additional capital would be put into public sector banks only after they improve the governance structure of public sector banks. The irony is that some of the biggest public sector banks have not had a CEO for many months now.
It had also asked the banks to reduce government stake to up to 52% and raise money directly from the stock market. But given the weak balance sheets of many of these banks, this option really does not exist.
To conclude, it is worth asking, why does the government of India need to own 26 public sector banks, especially in a scenario where many of these banks will require a lot of money to be invested in the next few years?
The best bet for the government is to go in for “strategic disinvestment” of most of these banks. Given their distribution network they may be good bets for the private sector. Further, the government can continue to own the State Bank of India and probably four other best public sector banks, in order to ensure that it is able to push through its financial inclusion programmes.

The column originally appeared on The Daily Reckoning on June 16, 2015