Band aid for banks

| Updated on January 06, 2021

Instead of ad hoc steps, the Centre needs to push long-term reforms in public sector banks

The Centre’s recent announcement of a modified recapitalisation bond to be issued to Punjab and Sind Bank highlights the tight fiscal situation and also points to how it is fast running out of options to rescue beleaguered public sector banks (PSBs). Instead of piecemeal fund infusions, which are only used to make good the losses arising due to bad loans, the Centre needs to get serious about implementing the long-pending reforms in PSBs. The manner in which the fund infusion into Punjab and Sind Bank is designed raises concerns about adherence to fair accounting practices. The Centre will subscribe to the bank’s preferential shares worth ₹5,500 crore with the funds raised through the sale of special non-interest bearing government bonds maturing from 2030-35, to the bank. While the Centre has used the recapitalisation bonds route to infuse funds into banks in the past, this time the bonds will not bear any interest, nor will they be issued at a discount.

The earlier issuances of the recapitalisation bonds were cleverly designed, so that they were liquidity neutral for the government and did not affect its Budget, but for the interest component. But the increase in the interest burden due to these bonds is beginning to hurt the Centre. According to an analysis published in this newspaper recently, the recapitalisation bonds issued to the PSBs, valued at ₹2.60-lakh crore between January 2018 and March 2020, resulted in interest payout of ₹48,000 crore between FY19 and FY21. Further, the Centre is expected to pay interest amounting to ₹1.2-lakh crore from FY21 to FY25. The Centre’s overall interest burden is already at unbearable levels, budgeted at around ₹7-lakh crore for FY21, accounting for 27 per cent of the revenue expenditure. The extra borrowing due to the pandemic will further increase this cost.

Yet, non-interest bearing recapitalisation bonds are not an apt solution. While the RBI is yet to express its view on how these instruments should be accounted for, the banks’ purchase of an investment that does not yield any return will be difficult to show in the bank’s balance-sheet and will depress its return on assets. Instead of resorting to patchwork steps, long-term solutions are in order to improve governance and attract investors into PSBs. Despite the PSBs trading at a very low valuation, investors are wary of putting money into them, thanks to shabby governance and a large bad loan book. The creation of a holding company that has control of the government’s investment in PSBs and empowering the bank boards to be autonomous will go a long way in building confidence among prospective investors. Once a strong governance framework is established, the government should reduce its stake in PSBs to below 50 per cent — further enhancing performance and efficiency through autonomy.

Published on January 06, 2021

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