1.A bold step in bank reform (The Hindu)

1.A bold step in bank reform (The Hindu)

Synoptic line: It throws light on the issue of recapitalisation of public sector banks. (GS paper III)

Overview

  • India’s economic growth faltering in the last couple of years, the government has been casting about for ways to galvanise the economy. After demonetisation, this year growth has been pushed through the goods and services tax (GST), this is hugely positive over the medium term, but is painful in the short run. 

Assessment

  • The government have realised that a simpler, more effective remedy is to recapitalising public sector banks (PSBs) and enhancing the flow of credit. The proposal to recapitalise PSBs to the extent of ₹2.11 trillion is a winner by any reckoning, it seems to be the most effective way to provide a much-needed fiscal stimulus to the economy and revive growth.

Bank recapitalisation

  • For understanding the significance of bank recapitalisation, there is need of a little primer on bank capital. Regulation requires that banks hold assets only in proportion to the capital they have. ‘Capital’ is a combination of equity, equity-like instruments and bonds.
  • For a given balance sheet, there is a certain minimum of capital that banks must hold. This is called ‘capital adequacy’. The higher the capital is above the regulatory minimum, the greater the freedom banks have to make loans. The closer bank capital is to the minimum, the less inclined banks are to lend. If capital falls below the regulatory minimum, banks cannot lend or face restrictions on lending.
  • The non-performing assets (NPAs) tends to erode bank capital and put the brakes on loan growth. That is precisely the situation PSBs have been facing since 2012-13. Stressed advances’, which represent non-performing loans as well as restructured loans have risen from a little over 10% in 2012-13 to 15% in 2016-17. This has caused capital adequacy at PSBs to fall.
  • Average capital at PSBs has fallen from over 13% in 2011-12 to 12.2% in 2016-17. The minimum capital required is 10.5%. An estimated 10 out of 20 PSBs have capital of just one percentage point above the minimum or less. Between 2009-10 and 2014-15, annual credit growth was in the range of 15-20%. In the ‘India Shining’ period of 2004-09, credit growth had been over 20%.
  • The introduction of GST has increased small business demand for working capital. Low growth in credit is confined to PSBs. Private banks have seen loan growth of 15% this year.
  • The government has misunderstood the problem, the bad loan problem at PSBs is not entirely the result of mismanagement. There have certainly been cases of malfeasance and poor appraisal of credit. However, as the Economic Survey of 2016-17 made clear, these are not responsible for the bulk of the NPA problem. The problem is overwhelmingly the result of factors extraneous to management.
  • PSBs, had lent heavily to infrastructure and other related sectors of the economy. Following the global financial crisis of 2007, sectors to which PSBs were exposed came to be impacted in ways that could not have been entirely foreseen. Blaming PSBs for the outcomes and starving them of capital was not the answer.
  • The International Monetary Fund has documented 140 episodes of banking crises in 115 economies in the world in the period 1970-2011. The median cost of bank recapitalisation in these crises was 6.8% of GDP. India’s cost of recapitalisation over a 20-year period is less than 1% of the average GDP during this period.

Way ahead

  • The Government of India’s decisive package to restore the health of the Indian banking system is in the view of the RBI a monumental step forward in safeguarding the country’s economic future.

Question– The government’s move to recapitalise banks can change the picture. Discuss the steps taken by the government for bank recapitalisation.