{"id":5778,"date":"2017-10-25T18:03:06","date_gmt":"2017-10-25T12:33:06","guid":{"rendered":"https:\/\/teekhapan.wordpress.com\/?p=5778"},"modified":"2017-10-25T18:03:06","modified_gmt":"2017-10-25T12:33:06","slug":"if-pm-modi-could-sell-notebandi-why-not-bankbandi-many-banks-do-not-deserve-fresh-capital","status":"publish","type":"post","link":"https:\/\/vivekkaul.com\/2017\/10\/25\/if-pm-modi-could-sell-notebandi-why-not-bankbandi-many-banks-do-not-deserve-fresh-capital\/","title":{"rendered":"If PM Modi could sell Notebandi why not Bankbandi? Many banks do not deserve fresh capital"},"content":{"rendered":"
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One of the examples of Big Government I have in my book\u00a0India’s Big Government<\/a><\/em>\u00a0is that of government owned public sector banks. (The good news is that the book is available at a huge discount on Amazon till Friday, 27th October.\u00a0The Kindle version is going at Rs 199<\/a>, against a maximum retail price of Rs 749, and\u00a0the paperback is going at Rs 499<\/a>, against a maximum retail price of Rs 999).<\/p>\n When I wrote the book, the Indian government owned 27 public sector banks. As of April 1, 2017, the Bhartiya Mahila Bank and the five associate banks of State Bank of India, were merged with the State Bank of India. Due to this merger, the number of government owned banks fell to 21. This merger has\u00a0pulled down the overall performance<\/a>\u00a0of the State Bank of India and is just a way of sweeping problems under the carpet. Over the years, the government plans to use mergers to reduce the number of banks it owns to anywhere between ten to fifteen. This as I have said in the past is a bad idea.<\/p>\n Yesterday afternoon, the finance ministry announced a plan to invest more capital in public sector banks, which are saddled with a massive amount of bad loans and restructured loans. The government plans to put in Rs 2,11,000 crore over the next two years, “with maximum allocation in the current year”.<\/p>\n Where will this money come from? Rs 18,139 crore has been allocated from the current financial year’s budget. Banks are expected to raise capital by issuing new shares. This is expected to raise around Rs 58,000 crore.<\/p>\n This leaves us with around Rs 1,35,000 crore. Where will this money come from? This money is expected to come in through recapitalisation bonds. How will this work? The government hasn’t specified the details of how these bonds will be issued. (This makes me wonder as to why have a press conference in the first place, when the most important part of the plan, has not been decided on).<\/p>\n From what I could gather speaking to people who understand such things, this is how it is supposed to work. The banks have a lot of liquidity because of all the money that has come in because of demonetisation. A part of these deposits will be used by public sector banks to buy recapitalisation bonds issued by the government.<\/p>\n The money that the government thus gets will be used to buy fresh shares that the banks will issue. Thus, the banks will be recapitalised.<\/p>\n Now on the face of it, this sounds like a brilliant plan, where money is moved from one part of the balance sheet to another and a huge problem is solved. But is it as simple as that?<\/p>\n a)<\/strong>\u00a0By issuing recapitalisation bonds the debt of the government will go up. Over and above this, interest will have to be paid on these bonds. Both the debt and the interest will add to the fiscal deficit of the government.<\/p>\n b)<\/strong>\u00a0Given that the debt of the government will go up, this would mean that the taxpayers will ultimately pick up the tab because the debt will have to be repaid. It makes sense to always remember that there is no free lunch in economics. The corollary to this is that there is no free lunch especially when something feels like a free lunch. Of course, the taxpayers aren’t organised and hence, they are unlikely to protest. And given that they finance all bailouts.<\/p>\n c)<\/strong>\u00a0It remains to be seen what the banks do with this extra capital. Will they use it to write off restructured loans of corporates? Will this dull their enthusiasm (not that they had enough of it in the first place) to recover bad loans? As the situation changes, so will the behaviour of bankers.<\/p>\n This will also bring to the fore the issue of moral hazard. And what is moral hazard? As Mohamed A El-Erian writes in\u00a0The Only Game in Town:\u00a0“[It] is the inclination to take more risk because of the perceived backing of an effective and decisive insurance mechanism.”<\/em>\u00a0If the government bails them around this time around, the banks know that they can count on the government bailing them out the next time around as well. And this means that they can follow fairly loose standards of lending, in order to lend money quickly.<\/p>\n d)<\/strong>\u00a0As I keep saying, bank lending among other things is also a function of whether there is demand for such lending. The public sector banks have gone slow on lending to corporates (in fact they have contracted their loan book) because of a lack of capital. Or so we are told. But this lack of capital doesn’t seem to have hindered their lending to the retail segment. Now that they will have access to more capital, will this reluctance to lend to corporates go away? I am not so sure.<\/p>\n e)<\/strong>\u00a0Also, some of the banks are in such a bad state, that they really don’t deserve this capital. They shouldn’t be in the business of banking in the first place. Take a look at Table 1. Table 1, lists out the bad loans ratio of all the public sector banks. Bad loans are essentially loans in which the repayment from a borrower has been due for 90 days or more.<\/p>\n Table 1:<\/p>\n