All you wanted to know about recapitalisation bonds

Eeconomic updates by the finance ministry seldom get the stock market to dance a jig. But the FM’s press conference on October 24 did. The Centre announced that it was working on a ₹2.11 lakh crore recapitalisation package for PSBs. Two elements didn’t come as a surprise — the ₹18,139 crore infusion from the Budget and the ₹58,000 crore to be raised from PSB stake sales. But a ₹1.35 lakh crore windfall from recapitalisation bonds sent the Nifty PSU Bank Index shooting up by 30 per cent and added over ₹1 lakh crore in market wealth to PSBs.

What is it?

Given that the markets are seldom overjoyed with the Government borrowing money, why were they so pleased with Recap Bonds? Expectations are that this recap exercise will follow in the footsteps of the one in the mid-nineties when, after PSBs got into hot water with sky-high NPAs, the government of the day issued Special Bonds to PSBs to borrow money. It then used the money to acquire equity shares in the very same banks. Through this bit of creative accounting, deposits held by PSBs were neatly morphed into equity capital, with no actual cash changing hands.

Depositors didn’t suffer because their bank had simply lent money to the Centre by way of Recap Bonds, at a fixed interest rate. PSBs were happy because they received interest on the bonds and also got capital.

The Government had wriggled out of a tight corner by tapping into the banks’ own kitty, and not raising new taxes, to rescue PSBs. Dividends and price gains from PSB shares also helped make up for the interest outgo.

Why is it important?

With the gross NPAs of Indian banks topping 10 per cent of loans recently, banks, RBI and the new Insolvency Board have been fire-fighting to bring defaulting companies to book. But this exercise will entail haircuts of 40 to 50 per cent for PSBs. To provide for this and meet capital norms under Basel III rules, PSBs are estimated to need aggregate equity infusions of about ₹2.4 lakh crore over the next couple of years. The Government being the majority shareholder in PSBs is obliged to provide this capital or sell its stakes so that PSBs can raise this money from the market. The market route has been a challenge.

While some commentators argue that the best way to resolve this mess would be to allow stressed PSBs to wind up, its impact on depositor confidence and the economy is hard to gauge. Not only do PSBs sit on over two-thirds of the public deposits in India, depositors perceive them as sovereign-backed. Recap Bonds can rescue PSBs without roiling the market. But a lot will depend on how the bonds are structured. The issuer, interest rate, subscribers and banks who will receive the capital, are all as yet unknown.

Why should I care?

If Recap Bonds become a reality, you may be relieved that the Government is standing firmly behind your bank. As a stock market investor, you may find that a large out-of-favour sector is now back in the reckoning.

As a taxpayer though, you need to worry about PSBs requiring big-ticket bailouts from the Centre once every few years. Quick-fix solutions are also a problem for investors, depositors and taxpayers in the long run because they create moral hazards for both bankers and corporate borrowers to take undue risks with depositors’ money.

The bottomline

The quick money has been made on Recap Bonds in the market. The devil now lies in the details.

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