More capital for public sector banks

The government has made a welcome about-turn on the question of infusing fresh capital into public sector banks (PSBs). It plans to infuse Rs 70,000 crore in the next four years, starting with Rs 25,000 crore this very year. The government's position in the first year in office was that the government would reward performing banks with capital; non-performers would have to fend for themselves.

This is an untenable position to take because it leaves unaddressed the issue of how non-performers are to fend for themselves. They can raise capital from the markets, if at all, only at throw away prices, which means the government as the owner is giving away equity cheaply. It makes sense to tap capital markets only after valuation improves. Valuations can improve only if revenue and profit grow. Revenue and profit can grow only if banks can lend more. (Options such as selling off non-core assets may not fetch enough capital and they cannot be done in a hurry in the government scheme of things), And banks can lend more only if they have more capital. QED.

The government's hand has, perhaps, been forced by the rise in NPAs in recent months. Provisions against these will reduce profit or increase losses and erode capital. It's not clear what level of capital adequacy the additional infusion of capital is intended to achieve- hopefully it will be at least two percentage points above the regulatory minimum of 9%- only then can PSBs take some risks in lending.

The general perception is that bouts of recapitalisation of PSBs are uncalled for and a colossal drain on the exchequer. Neither is true when one looks at the worldwide experience with bank recapitalisation. There is always a fiscal cost associated with recapitalising banks. If you can keep the cost below, say, 5% of average GDP over a 20 years and prevent a banking crisis, you have achieved something.

In India, we have done just that and we have prevented a full-blown crisis. Contrast that with economies where governments recapitalise banks after a crisis and end up paying a higher fiscal cost, not to speak of the bigger loss of output arising from a banking crisis.

More in my article in the Wire, Three myths about recapitalising public sector banks.