Public Sector Banks

Indradhanush framework is not “sanjivini booti” for govt banks

rainbow
On August 14, 2015, the ministry of finance released the Indradhanush framework for transforming the government owned public sector banks (PSBs), which are currently in a bad shape primarily due the bad loans that have piled up over the years.

In fact, the press release accompanying the announcement was extremely self-congratulatory in nature and pointed out: “Indradhanush framework for transforming the PSBs represents the most comprehensive reform effort undertaken since banking nationalisation in the year 1970. Our PSBs are now ready to compete and flourish in a fast-evolving financial services landscape.”

The framework has seven steps, and hence has been named Indradhanush or rainbow (which has seven colours). Enough has been written in the mainstream media regarding what these steps are. Hence, in this column I will concentrate on what is missing in the Indradhanush framework and why it is unlikely to help the public sector banks in a major way.

The third step in the Indradhanush framework talks about the government putting in Rs 70,000 crore into these banks over the next four years. Of this Rs 50,000 crore will be invested in the current and the next financial year.

There are a number of questions that crop here. The first question is whether this is going to enough? 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 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.

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 97,500 crore assuming $1 = Rs 65) is needed in these banks.

The international rating agency Standard & Poor’s said: “The Central government’s planned capital infusions come at a good time for public sector banks. But they don’t go far enough.”

So, the government is clearly not investing as much as the public sector banks really need to get out of the current mess that they are in. Further, as I have pointed out in the past, the government putting in more money into public sector banks goes totally against the “minimum government maximum governance” philosophy that Narendra Modi had espoused in the run-up to the Lok Sabha elections that happened last year.

This does not mean that the government should abandon these banks. But there is no reason that it should own 25 public sector banks, especially given that they require a massive amount of money to continue functioning. It is best to own five or six big banks and sell out of the others. In this way it will be able to concentrate its efforts on managing the big banks. At the same time, it will get more bang for the buck on the money that it is putting into the public sector banks.

This brings me to the next point I want to make. There is nothing in the Indradhanush framework that talks about the government trying to sell its stake in the public sector banks. Many public sector banks have a very good branch network in place and hence, will be attractive buys despite their balance sheets being in a mess.

This non-reference to disinvestment is not surprising given that it will be a politically very difficult thing to do. And from whatever evidence we have had from the Modi government up until now, it has shown no zeal to push through politically difficult reform. Given this, the government will continue to own 25 banks and hence, it is likely to pump more tax payer money into these banks in the days to come, because Rs 70,000 crore is clearly not going to be enough.

The fourth point in the Indradhanush framework talks about de-stressing public sector banks. The press release has a long-winded paragraph written in a fine bureaucratic way which comes up with practically every possible reason to explain the bad loans that have piled up with public sector banks.

Here it goes (you won’t miss much if you decide to skip it): “Due to several factors, projects are increasingly stalled/stressed thus leading to non-performing assets(NPAs) burden on banks. In a recent review, problems causing stress in the power, steel and road sectors were examined.  It was observed that the major reasons affecting these projects were delay in obtaining permits / approvals from various governmental and regulatory agencies, and land acquisition, delaying Commercial Operation Date (COD); lack of availability of fuel, both coal and gas; cancellation of coal blocks; closure of Iron Ore mines affecting project viability; lack of transmission capacity; limited off-take of power by Discoms given their reducing purchasing capacity; funding gap faced by limited capacity of promoters to raise additional equity and reluctance on part of banks to increase their exposure given the high leverage ratio; inability of banks to restructure projects even when found viable due to regulatory constraints.  In case of steel sector the prevailing market conditions, viz. global over-capacity coupled with reduction in demand led to substantial reduction in global prices, and softening in domestic prices added to the woes.”

There is no mention of how the banks are going to go about recovering the loans that they have given out and which are not being repaid. As an editorial in The Financial Express points out: “The lack of a concrete plan to tackle NPAs is worrying. There is no mention of how the debt of state electricity boards (SEBs), running into several lakh crore rupees, is going to be recovered or that from wilful defaulters or highly-leveraged promoters.”

Further, many measures that the government has listed out as a part of the Indradhanush framework have already been around for a while now, having been put in place by the Reserve Bank of India.

The fifth point in the Indradhanush framework talks about “no interference from government,” in the functioning of banks. It further states that “banks are encouraged to take their decision independently keeping the commercial interest of the organisation in mind.”

How are banks supposed to interpret this point given that in his Independence Day speech Prime Minister Narendra Modi talked about “Start-Up India, Stand-Up India”. The idea, as Modi explained during the speech, is that each of the 1.25 lakh bank branches all across India “should encourage at least one Dalit or Adivasi entrepreneur, and at least one woman entrepreneur”.

So how independent does this make the banks, given that they have to follow diktats like these from the government? Also, it is worth mentioning here that lending to start-ups is a very high risk kind of lending. Further, do public sector banks have the capability to analyse the loan proposals of start-ups, is a question worth asking here.

To conclude, it is safe to say that the Indradhanush framework is essentially a clever repackaging of steps and processes that are already in place. It is not the sanjivini booti that it is being made out to be.

The column originally appeared in The Daily Reckoning on August 20, 2015

With Rs 70,000 cr bailout of banks, Modi’s minimum govt vision has gone for a toss

narendra_modi
The government of India has planned to put in Rs 70,000 crore into public sector banks over the next four years. “As of now, the PSBs are adequately capitalised and meeting all the Basel III and RBI norms. However, the government wants to adequately capitalise all the banks to keep a safe buffer over and above the minimum norms of Basel III. We have estimated how much capital will be required this year and in the next three years till financial year 2019,” a ministry of finance press release pointed out.

The press release further pointed that: “If we exclude the internal profit generation which is going to be available to PSBs (based on the estimate of average profit of the last three years), 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.  This estimate is based on credit growth rate of 12% for the current year and 12 to 15% for the next three years depending on the size of the bank and their growth ability.”
This theme of rescuing public sector banks is something I have discussed in the past. And honestly, I am disappointed with the government deciding to spend to so much money over them. There are number of reasons for the same.

The latest release by the ministry of finance suggests that public sector banks are going to need Rs 1,80,000 crore of extra capital over the next four years. Of this amount the government plans to plough in Rs 70,000 crore.

(i)Financial Year 2015 -16–Rs. 25,000 crore

 

(ii)Financial Year 2016-17–Rs. 25,000 crore

 

(iii)Financial Year 2017-18–Rs. 10,000 crore

 

(iv)Financial Year 2018-19–Rs. 10,000 crore

 

 Total Rs. 70,000 crore

 

Source: Press Information Bureau

These numbers are very different from the numbers put out by the PJ Nayak committee report released in May 2014. The 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 difference between the number put out of by the ministry of finance last week and the number put out by the PJ Nayak committee is huge. The PJ Nayak Committee said that the government would need to invest Rs 3,50,000 crore by March 2018. The government is investing only Rs 70,000 crore by March 2019. If the PJ Nayak Committee number is the amount of money that is required then the money being put in by the government is basically small change.
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. Either ways what the government plans to invest is too small in comparison to what may be required at this point of time.

Further, other than requiring a massive infusion of money, these banks continue to face a significant amount of bad loans. As the latest RBI Financial Stability Report released in June 2015 points out: “Five sub-sectors, namely, mining, iron & steel, textiles, infrastructure and aviation, which together constituted 24.8 per cent of the total advances of scheduled commercial banks, had a much larger share of 51.1 per cent in the total stressed advances. Among these five sectors, infrastructure and iron & steel had a significant contribution in total stressed advances accounting for nearly 40 per cent of the total. Among the bankgroups, public sector banks, which had the maximum exposure to these five sub-sectors, had the highest stressed advances.”

Around 30.5% of the stressed advances of public sector banks come from the infrastructure sector. Nearly 10.5% comes from iron and steel sector.
The stressed assets are arrived at by adding the gross non performing assets(or bad loans) plus restructured loans divided by the total assets held by the Indian banking system. The borrower has either stopped to repay this loan or the loan has been restructured, where the borrower has been allowed easier terms to repay the loan by increasing the tenure of the loan or lowering the interest rate.

The trouble is that many public sector banks have essentially been using the restructuring route to avoid recognising bad loans as bad loans.  The Morgan Stanley report referred to earlier points out: “The current managements’ policy of “extend and pretend” is causing banks to move further into problems.”
The banks have been kicking the can down the road by refusing to recognise bad loans upfront. In a research note published earlier this year, Crisil Research estimates that 40% of the loans restructured during 2011-2014 have become bad loans. Morgan Stanley estimates that 65% of restructured loans will turn bad in the time to come.

What this tells us actually is that any capital infusion will essentially not amount to much given that bad loans will keep piling up. In a research report titled Current Worries Crisil Ratings has estimated that “around 46,000 mw of power generation projects (36,000 mw coal-based and 10,000 mw gas-based) are in distress today. Loans to these projects are around Rs 2.1 lakh crore, with about two-thirds lent by public sector banks.”

Further, of these loans “as much as Rs 75,000 crore of loans – or nearly 15% of aggregated debt to power generation companies — are at risk of becoming delinquent in the medium term.”

So, along with putting money in public sector banks the government needs to come up with a plan on how to stop these banks from bleeding. Any capital infusion plan is incomplete without a plan on how to counter mounting bad loans. As S.S. Mundra, deputy governor of the Reserve Bank of India said in a recent speech: “The issue is how to deal with imprudent and non-co-operative borrowers, wilful defaulters or for that matter, fraudsters? It is important that the errant borrowers are quickly brought to book and recovery proceedings be completed as early as possible. A non-performing account of whatever origin and pedigree, is a drag on the banking system and increases the cost of intermediation, which pinches an honest borrower the most. It is important for the system to weed out the unethical elements at the earliest opportunity to ensure the credibility and the efficiency of the credit system in the country.”

Further, as I have pointed out in the past, why does the government need to own 25 public sector banks? There is clearly no point in continuing to own 25 banks, especially given that they require a massive amount of money to continue functioning.

The government plans to allocate Rs 25,000 crore to these banks during the course of this year. Of this around 40% (Rs 10,000 crore) the second tranche will be allocated to the top six banks (State Bank of India, Bank of Baroda, Bank of India, Punjab National Bank, Canara Bank and IDBI Bank). This will be done “in order to strengthen them to play a vital role in the economy,” the ministry of finance press release pointed out.

The question is why doesn’t the government concentrate on these six banks and sell off the remaining banks. Yes, it will be politically difficult. But why should the tax-payer keep bailing these banks out?

Further, as prime-minister Narendra Modi has said in the past: “I believe government has no business to do business. The focus should be on Minimum Government but Maximum Governance [the emphasis is mine].” This was his chance to implement this vision. But sadly that doesn’t seem to be happening.

The column was originally published on The Daily Reckoning on August 4, 2015

Rajan is right, the window dressing of bad loans by banks should end

ARTS RAJANVivek Kaul

The Reserve Bank of India (RBI) Raghuram Rajan was speaking at a function to inaugurate the Meghanand Desai Academy of Economics in Mumbai, yesterday (July 28, 2015). Normally, whenever the RBI governor makes a speech, a copy of the speech is made available on the RBI website.

But as I write this on the afternoon of July 29, 2015, the speech is yet to be uploaded on the RBI website. Media reports suggest that the PR agency handling the event sent out a press release yesterday. A report in The Economic Times quotes the press release and points out that one of the things that Rajan had said during the course of the speech: “Declaring an NPA (non-performing asset) is primarily an issue of cleaning up accounting…The market fully understands what is truly non-performing. Moreover, it gives the wrong incentives, as by avoiding NPAs it merely postpones the problem. There is confused understanding of this problem.”

After sending out the press release, the PR agency withdrew the release and sent out another release in which the above statement attributed to Rajan in the first release was missing. The event was closed to the media.

Irrespective of whether Rajan said it or not, the fact that banks need to recognise their non-performing assets i.e. loans which have gone bad, on time, is a very important point. What makes this point even more important is the fact that the lending carried out by public sector banks over the last few years, particularly to the infrastructure sector, will continue to go bad in the days to come.

In a research report titled Current Worries Crisil Ratings estimates that “around 46,000 mw of power generation projects (36,000 mw coal-based and 10,000 mw gas-based) are in distress today. Loans to these projects are around Rs 2.1 lakh crore, with about two-thirds lent by public sector banks.”
Of these loans “as much as Rs 75,000 crore of loans – or nearly 15% of aggregated debt to power generation companies — are at risk of becoming delinquent in the medium term.”

“Further, close to Rs 1.9 lakh crore of loans to six weak discoms, wherein the moratorium under the financial restructuring package (FRP) is ending in the next 18 months, are also at risk if timely support is not extended by the central or state governments,” Crisil points out.

The rating agency feels that the risk is highest in 16,000 mw of projects. “These projects don’t have strong sponsor company support and are not expected to turn viable in the long run even if they are structured under the 5/25 scheme. The exposure of banks and FIs to them was about Rs 75,000 crore as on March 31, 2015. CRISIL believes accretion of non-performing assets (NPAs) from these accounts could be high in medium term.”

This is a worrying sign given that loans to the power sector form 8.3% of the total advances made by scheduled commercial banks. In case of the public sector banks the number is higher at 10.1%. Further, advances to the power sector form 16.1% of the total stressed advances. In case of public sector banks, the number is even higher at 17.3%.

The stressed asset ratio is the sum of gross non performing assets (or bad loans) plus restructured loans divided by the total assets held by the Indian banking system. The borrower has either stopped to repay this loan or the loan has been restructured, where the borrower has been allowed easier terms to repay the loan by increasing the tenure of the loan or lowering the interest rate, which entails a loss for the bank.

Hence, if the stressed advances of public sector banks to the power sector are at 17.3%, it means that of every Rs 100 of loan given to the power sector by the banks, Rs 17.3 has either gone bad or has been restructured.

The power sector in India has been facing many problems. As the RBI Financial Stability Report released in June 2015 points out: “The power sector in India…has been facing significant problems in terms of fuel availability / linkages, project clearances, social activism and aggressive bidding in coal block auctions by power producers resulting in lower plant load factors (PLF). Dependence on imported coal, which is three to four times more expensive, impinges on the bottom lines of companies.”

All these reasons have led to power companies not being able to pay the loans that they had taken on. And this is likely to continue in the days to come, meaning more trouble for banks in general and public sector banks in particular.

It is important that as and when these loans turn bad, they are recognised as bad loans. But that is not something that Indian banks have done over the past few years. Their tendency has been to not recognise the problem and kick the can down the road.

In a research note titled A Growing Need for Indian TARP, Anil Agarwal, Sumeet Kariwala and Subramanian Iyer, analysts at Morgan Stanley point out: “The current managements’ policy of “extend and pretend” is causing banks to move further into problems.”

What do they mean by this? Crisil Research estimates that 40% of the loans restructured during 2011-2014 have become bad loans.

A loan is said to have been restructured where the borrower is allowed to repay the loan over a longer period of time than was originally scheduled. Or the rate of interest on the loan is decreased. If 40% of the loans that were restructured have gone bad over the years, what it clearly shows is that banks have used the restructuring route to essentially kick the can down the road and not recognise the bad loan problem upfront.

The Morgan Stanley analysts quoted earlier expect nearly 65% of restructured loans to turn into bad loans. This is what Rajan was supposedly worried about in his speech in Mumbai yesterday. 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.”

Another sector where the banks have been busy window dressing their bad loans is the steel sector. The sector is in a mess with too much debt and is earning too little money to be able to repay it. As Neelkanth Mishra India Equity Strategist, Credit Suisse points out in a recent column in The Indian Express: “At the end of the last financial year, the total debt outstanding to Indian steel companies was nearly $50 billion. This was nearly ten times the industry’s ebitda (profits before interest, taxes and depreciation are deducted), a good proxy for cash profits.” What this clearly tells us is that the steel industry has borrowed way too much and is really not in a position to repay.

The industry continues to be in a mess due to various reasons. As the RBI Financial Stability Report points out: “the industry is beset with many problems: inadequate capital investments, shortage of iron ore, low paced mechanisation of mines, lower level of capacity utilisation of coal washeries, dependence on imported coking coal (the quality of most of the domestic coking coal is not considered good for steel production)…land acquisitions and environmental clearances issues…deceleration in domestic demand.”

In fact, the industry is even finding it difficult to pay the interest on the debt that they have taken on from banks. As Mishra writes: “Companies are borrowing from banks to pay their interest—as underscored by the many “refinancing” deals recently for broke steel companies, where an additional R5,000-8,000 crore were lent by banks.”

Guess, Rajan if he said what he did, was merely stating the obvious.

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

The column originally appeared on Firstpost on July 29, 2015

Arghhh, Mr Jaitley it’s still not about cutting interest rates

Fostering Public Leadership - World Economic Forum - India Economic Summit 2010
The finance minister Arun Jaitley is at it again. A recent report in the Business Standard suggests that Jaitley is scheduled to meet public sector banking chiefs on this Friday i.e. June 12, 2015, and ask them why they haven’t cut interest rates in line with the Reserve Bank of India (RBI) cutting the repo rate.
The RBI has cut the repo rate by 75 basis points (one basis point is one hundredth of a percentage) to 7.25% since the beginning of this year. Repo rate is the rate at which RBI lends to banks. In response banks have cut their lending rates by only 30 basis points.
The finance minister wants to know why banks have not matched the RBI rate cut when it comes to their lending rates even though they have cut their deposit rates by close to 100 basis points over the last one year.
The finance minister believes that at a lower interest rate people and companies will borrow more, and banks will lend more. But as I have often said in the past this is a very simplistic assumption to make.
First and foremost a cut in the repo rate does not bring down the legacy borrowing costs of banks. Hence, lending rates cannot always fall at the same speed as the repo rate. Further, data from the RBI shows that as on May 15, 2015, nearly 29.9% of aggregate deposits of banks were invested in government securities. This when the statutory liquidity ratio or the proportion of deposits that should be invested in government securities, stands at 21.5%.
So what does this mean? Banks have way too much investment in government securities. In fact, as on May 15, 2015, the total aggregate deposits of banks stood at Rs 87,39,610 crore. Of this amount around 29.9% or Rs 26,14,770 crore is invested in government securities.
As things currently stand, banks investing Rs 18,79,016 crore in government securities would have been suffice to meet the regulatory requirement of 21.5%. What this means that banks have invested Rs 7,35,754 crore more than what is required in government securities.
Why is that the case? The answer could be lazy banking or the lack of decent loan giving opportunities going around. Clarity on this front can only come from banks doing the necessary explaining.
There are other things that Jaitley needs to consider as well. The bad loans or gross non-performing assets of banks have been going up. As on March 31, 2014, they had stood at 3.9% of their total advances. By March 31, 2015, the number had shot up to 4.3% of the total advances.
The situation is worse in case of public sector banks. As on March 31, 2015, the stressed asset ratio of public sector banks stood at 13.2%. The stressed assets ratio of public sector banks as on March 31, 2014, was at 11.7%. The stressed asset ratio of the overall banking system was at 10.9% as on March 31, 2015 and 9.8% as on March 31, 2014.
The stressed asset ratio is the sum of gross non performing assets(or bad loans) plus restructured loans divided by the total assets held by the Indian banking system. The borrower has either stopped to repay this loan or the loan has been restructured, where the borrower has been allowed easier terms to repay the loan by increasing the tenure of the loan or lowering the interest rate. Hence, a stressed assets ratio of 13.2% essentially means that for every Rs 100 given out as a loan, Rs 13.2 has either been defaulted on or has been restructured.
What this clearly tells us is that the situation of the public sector banks has gone from bad to worse, over the last one year. In this situation it is hardly surprising that the banks have cut their fixed deposit rates but haven’t cut their lending rates by a similar amount.
With increased bad loans, they need to earn a higher margin on their good loans, to maintain or increase the level of profits. This scenario has arisen primarily because many corporates have been unable to repay the loans they had taken on.
Banks have not been able to recover these loans. A newsreport in The Economic Times yesterday, pointed out that the RBI is mulling a new rule that will give lenders a 51% equity control in a company, which fails to repay a loan even after its loan conditions have been restructured. Whether this happens remains to be seen. Further, many companies which failed to repay loans belong to crony capitalists who continue to be close to politicians.
Also, it needs to be pointed out that the corporate profits as a share of the gross domestic product is at 4.3% of the GDP, which is the lowest since 2004-2005. (I would like to thank Anindya Banerjee who works with Kotak Securities for bringing this to my notice).
What this tells us is that corporates as a whole are still not earning enough to be able to repay any fresh bank loans that they may take on. In this scenario insisting that the banks cut interest rates and lend is not the most suitable suggestion to make.
The Economic Survey released earlier this year had a very interesting table, which I have reproduced here.

Top Reasons for stalling across ownership

Source : CMIE

What the table clearly shows is that a lack of funds is not one of the main reasons for the 585 stalled projects in the private sector. In case of the 161 stalled government projects, the lack of funds is the third major reason. Hence, there are other reasons which the government needs to tackle, in order to get these projects going again. Lack of finance is clearly not a main reason.
Further, the high interest rates on post office savings schemes put a floor on the level to which banks can cut their fixed deposit rates and in the process their lending rates. This is something that the public sector banks can do nothing about.
To conclude, what all these reasons clearly suggest is that Arun Jaitley and this country would be better off if we got rid our fixation for lower interest rates being a solution to reigniting economic growth. There are other bigger things that need to be sorted out first.

The column originally appeared on The Daily Reckoning on June 9, 2015

There is no plan in sight for public sector banks

rupee-foradian.png.scaled1000One of the points that I forgot to talk about in the recent Master Series chat (“Looking Behind The Modi Smokescreen with Vivek Kaul”) that I and Rahul had, was the bad state of public sector banks in India.
As S S Mundra, one of the Deputy Governors of the Reserve Bank of India pointed out in a recent speech: “asset quality [of banks] has seen sustained pressure due to continued economic slowdown.” The primary reason for this is the fact that banks have lent too much money to companies. And many companies right now are not in a position to repay the loans they had taken on.
The gross non-performing assets(or bad loans) of banks have been on their way up. As on March 31, 2014, they had stood at 3.9% of their total advances. By March 31, 2015, the number had shot up to 4.3% of the total advances. Crisil Research expects this number to touch 4.5% of the total advances of banks, during the course of this financial year.
What is worrying is 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.
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. As Crisil Research points out in a recent 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.”
And this is clearly worrying. In fact, Mundra during the course of his speech went on to refer to the recent Global Financial Stability Report of the International Monetary Fund(IMF) and said: “Referring to the high levels of corporate leverage, the [IMF] report highlights that 36.9 per cent of India’s total debt is at risk, which is among the highest in the emerging economies while India’s banks have only 7.9 per cent loss absorbing buffer, which is among the lowest. While these numbers might need an independent validation, regardless of that, it underscores the relative riskiness of the asset portfolio of the Indian banks.” This statement coming from one of the top officials of the RBI needs to be taken seriously.
Mundra also pointed out that because of this inability of corporates to repay loans that they had taken on, the public sector banks are in a much bigger mess than other banks.  He pointed out that the stressed assets ratio of banks in India as a whole stood at 10.9%.
The stressed asset ratio is the sum of gross non performing assets(or bad loans) plus restructured loans divided by the total assets held by the Indian banking system. The borrower has either stopped to repay this loan or the loan has been restructured, where the borrower has been allowed easier terms to repay the loan by increasing the tenure of the loan or lowering the interest rate. Hence, a stressed assets ratio of 10.9% essentially means that for every Rs 100 given out as a loan, Rs 10.9 has either been defaulted on or has been restructured.
As Mundra pointed out: “The level of distress is not uniform across the bank groups and is more pronounced in respect of public sector banks…The stressed assets ratio[of public sector banks] stood at 13.2%, which is nearly 230 bps[one basis point is one hundredth of a percentage] more than that for the system.” The stressed assets ratio of public sector banks as on March 31, 2014, was at 11.7%. The overall stressed assets ratio of banks was at 9.8%.
This is indeed very worrying. Between March 31, 2014 and March 31, 2015, the stressed assets ratio of public sector banks has gone up a whopping 150 basis points. This has hit the capital that public sector banks carry on their balance sheets. As Mundra pointed out: “Our concerns are larger in respect of the public sector banks where the CRAR [Capital to Risk (Weighted) Assets Ratio also known as capital adequacy ratio] has declined further to 11.24% from 11.40% over the last year.”
The government seems to have made it more or less clear that it is unlikely to pump in any more money into the weaker public sector banks. Also, given the poor perception and stock price of these banks, they are unlikely to be able to raise capital from the stock market. In such a situation it is imperative they be very careful in handling the capital they have. “The need of the hour for all banks, and more specifically, in respect of the PSBs, is that capital must be conserved and utilized as efficiently as possible,” writes Mundra.
What Mundra means in simple English is that banks need to take almost no risk while lending. And this unwillingness of banks to lend has hit the infrastructure sector the most. As Crisil Research points out: “In the past, many private developers have bid aggressively for projects, especially in roads and power. However, most projects have seen execution delays due to issues such as fuel availability, land acquisition and environmental clearances; resulting in significant cost overruns….As a result, poor operational cash flows coupled with rising debt burden have led to a sharp deterioration in the debt-servicing ability of many companies. Banks, too, are wary of lending to the sector.”
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.” The budget for the year 2015-2016 provided Rs 11,200 crore towards this, which is not even peanuts given the kind of money that is required.
It is clear that the government does not have the kind of money that is needed to recapitalize the public sector banks. But the money is needed. What is surprising that even though one year has more or less elapsed since the Modi government came to power, no comprehensive plan has been put forward to solve the mess in the public sector banking space.

The column appeared on The Daily Reckoning on May 22, 2015