Analysis. How will the Centre infuse capital in PSBs?

Public sector banks need ₹4.6 lakh crore over the next four years as part of Basel-III requirements, and about ₹2.4 lakh crore has to come from the Centre as its equity contribution.

This is three times what the Centre has provided cumulatively over two decades for banks by way of capital infusion.

The Centreis planning to raise this amount partly through stake sale and partly through ploughing back its dividends and making budgetary provisions. The Centre has four years to do the needful since the implementation date is March 2019.

The Centre recently allocated a measly ₹6,990 crore among nine banks using the criteria of return on assets (RoA) and return on equity (RoE) to reward those who did better than the average. This marks a shift in strategy, since earlier infusions of capital were need-based. A retired top banker compared this policy to asking teams to play rugby, but having a cricket umpire and scoring like in cricket to judge the winners. He was alluding to the lack of a level-playing field as well as the multiple social responsibilities foisted on State-owned banks while expecting them to ace all commercial tests of efficiency.

While the usage of financial parameters as criteria to determine capital infusion is unexceptionable, this should have been made clear to the banks and their boards.

Till now public sector banks were recapitalised unconditionally by the government, despite moral hazards of that move. What could have been done was to provide recapitalisation on the basis of mutually agreed targets between the government and the banks. If banks did not meet the targets, then the correct thing would be to sack the management.

What about the banks who did not get funds?

The Centre has said that it will use these yardsticks of efficiency to infuse fresh capital into public sector banks, but it has left an important question unanswered: What will happen to those banks who do not meet the criteria but still need to beef up their capital?

Given that the Centre had an equity stake of 51per cent or more in most public sector banks, it is unclear how they will be able to evade the responsibility to recapitalise banks suitably. Asked about what banks could do meanwhile, the retired banker said that banks must improve revenue streams, diversify sources of fee income, cut down interest expense and improve the mix of business.

Easier said than done, as the banker himself conceded, and they are all medium-term solutions. For the short term, banks will have to shrink their lending and their balance sheet to meet the required norms, a move that, some surmise, could signal the start of a consolidation process.

Informed opinion in the banking industry feels that such shrinking of lending would have damaging consequences. Firstly, the unlucky banks which were not recapitalised may find their good customers migrating to other banks.

Second, their non-performing assets (NPA) ratios that are already on the rise will worsen further if lending curbs are imposed on them. Third, morale as well as valuations, already beaten, will be driven further lower. Now, these banks are technically free to raise capital from the market. It is a moot point, however, if ordinary investors will want to bail them out when the principal stakeholder refuses to.

In which case, the ball will be right back in the Centre’s court and it will most probably face the pressure to recapitalise these banks all at once. One way to avoid such a situation is start making sizeable allocations for capital from the forthcoming budget itself.

That would send the right signals of the Centre’s seriousness about recapitalisation as well as fiscal consolidation. The capital can be infused into banks at a later date based on meeting agreed targets, while they can be allowed to raise money from the market when conditions are appropriate. The Centre will also have to simultaneously pay heed to the task of timing the capital raising of different public sector banks so as not to present investors with a glut of bank paper at one time and then suffer poor valuations. This promises to be a long and arduous process.

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