Aside from prioritising investments, adopting an expansionary fiscal stance and pegging in a sharp increase in capital expenditure in FY22, the Budget has rightly taken several bold moves to strengthen the financial sector to ensure sustainable growth in the economy.

As was widely expected, the Centre has finally laid down a roadmap for privatisation of public sector banks (two to start with). While this can improve credit growth, bring in better operational efficiencies, and address the growing recap issue, implementation will be critical.

The government – the majority shareholder – has been injecting capital into PSBs year after year. But further recapitalisation has become challenging. Various estimates indicate that PSBs will require about ₹40,000-50,000 crore in FY22. Aside from the quantum of capital infusion, the other key issue lies in the government’s sizeable holdings, which impedes huge recapitalisation (over 90 per cent in few PSBs). Also, public sector bank boards are still not adequately professionalised, and the government still deciding on board appointments, has led to politicisation.

Privatisation of some PSBs can help address these issues. But it will be important to implement such a bold move in a planned manner. After all, it will be critical for the entity to have strong boards before it is privatised, lest the government selling down its stake may not find many takers. PSBs have been trading at 0.4-0.5 times book value for the past few years. But even such low valuations, haven’t kindled investor interest.

To push forth its wider set of objectives of state policy, the government can seek to retain full control of some large PSBs, and de-list them.

Finally, a bad bank

In a bid to ease banks’ capital and spur lending, the Budget has finally proposed the setting up of a bad bank. But will this help restore the health of the banking sector?

There are several issues that need attention while implementing such a proposal. For starters, assessing the amount of funding or capital that a bad bank requires will be critical as will be the mode of constant funding. In India, there are already 29 asset reconstruction companies. But ARCs have not been able to make a meaningful impact owing to multiple headwinds. One critical issue has been capital. ARC is a capital intensive business. While there are 29 ARCs, the top three ARCs constitute over 70 per cent of the industry. Owing to judicial delays in the recovery process, drawing investors has been difficult.

Also, steady recapitalisation of originating banks (selling bad loans to the bad bank) will also be imperative, as asset transfer is likely to occur at a price below the book value. How will the government raise resources to meet the overall funding requirement?

The next critical issue to be addressed will be pricing. Arriving at a consensus on pricing has been a key issue with banks and ARCs, more so because of the lack of a distressed asset market in India. In case of a bad bank a transparent and robust pricing mechanism will be all the more critical. Also, the bad bank will need institutional independence, ring-fencing it from political intervention.

Addressing all these issues will be critical for the bad bank to serve its intended purpose.

Insurance is an important route through which the Centre can raise stable long-term money. Hence, increasing the FDI limit in insurance to 74 per cent from 49 per cent can help bring in more capital into the sector. However, will raising the FDI limit alone draw foreign investors into the sector? Not necessarily, if past trends are any indication.

Also, the rationalisation of taxation of ULIPs, could impact some players which have a heavy ULIP portfolio and a higher ticket size.

The government had increased the FDI limit in insurance in 2015 to 49 per cent from 26 per cent. But five years after the limit was raised, only 8 life insurance players out of 23 private players, and 4 out of the 21 private general insurers have foreign promoter holdings of 49 per cent. Many insurance players still have foreign holdings of 26 per cent or even lower, according to data available for September 2020. Indian promoters still hold 100 per cent stake in companies such as Exide Life, Kotak Mahindra Life and Reliance General.

But given the broader picture across both life and general insurance players, it appears that raising the FDI limit alone may not assure easy access to capital. Also, while the mandate that the majority of directors on the board should be resident Indians is welcome, whether there will be any cap on voting rights of foreign shareholders needs to be seen.

In what could hurt the top line growth of few life insurance players, the Budget has sought to remove the tax exemption currently available on maturity proceeds of ULIPs (above annual premium of ₹2.5 lakh). This can hurt the growth of few life insurance players that have a heavy ULIP portfolio. Of the listed players, ICICI Pru Life and SBI Life have a relatively higher ULIP proportion in their product mix (48-62 per cent of annualised premium equivalent). HDFC Life will see minimal impact of the move. Also, its average ticket size is about ₹60,000 on ULIPs. For ICICI Pru Life the average ticket size on ULIPs is slightly higher at ₹1.8 lakh (as of FY20), and it could see some impact on its growth. However, the impact on profitability will be lower as ULIPs are lower margin business than protection products for life insurers.

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