The carnage seen on the Indian bourses on February 11, 2016 leading to erosion in market capitalization by a whopping Rs 300,000 crores [around US$ 44 billion] was led primarily by plunge in the stocks of public sector banks [PSBs].
Even as the near recessionary trends globally precipitated by deceleration in Chinese growth rate has been the undercurrent contributing to decline in Sensex/Nifty, steep fall in PSBs stocks in particular, is due to poor results of the third quarter [October-December, 2015] of the current financial year.
State Bank of India [SBI] – biggest of all PSBs in terms of size and market capitalization – reported a steep fall of around 60% in net profit for the quarter. Punjab National Bank [PNB] registered 90% fall and nearly escaped slipping in to loss. Canara Bank net plunged by similar magnitude. Other smaller banks followed suit.
Does this all point towards major cracks in PSBs? Will this snowball in to a crisis leading to erosion of public confidence? Is this a manifestation of systemic failure in our banking system? What is the government [the owner] and Reserve Bank of India [RBI] – the bank’s regulator – doing to stem the tide?
Given the ballooning non-performing assets [NPAs] plus the restructured assets [a glorified name for NPAs] that have assumed alarming proportions [close to 15% of gross advances], undoubtedly there exist major cracks in PSBs. But, thus far, successive political establishments and the head of RBI have hidden/camouflaged these cracks behind a smokescreen.
For the first time ever, we have a governor, Raghuram Rajan who does not believe in business as usual and is known for administering hard pill. And, we have a government led by a prime minister who also strongly believes in acting tough when it comes to delivering on good governance and reforms. It goes without saying that Modi has given a free hand to Rajan.
So, Rajan got an asset quality review [AQR] of all PSBs done, identified their loans under all kinds of nomenclatures viz., sub-standard, stressed etc and directed them to make provisions against them. They were ordered to clean up their balance sheets within a pretty harsh time line i.e. by March 31, 2017.
The governor was guided by a dictum that “banks balance sheet should be fully transparent and must honestly reflect the inherent value of their asset”. Unless ‘anaesthesia’ is administered to the patient [as he put it], surgery cannot be performed. By directing all PSBs to make provisions, he has already geared all of them to get ready for the surgery.
What we are witnessing from third quarter is the effect of administering the ‘anaesthesia’. Of the over Rs 20,000 crores fresh slippages [incremental bad loans] of SBI, around Rs 15,000 crores or 75% originated from AQR. As a result, the bad loan provision for the quarter was over Rs 7600 crores, 60% up from the third Qr of 2014-15. The AQR impact will persist during the fourth Qr and in to 2016-17 as well. Ditto for other banks.
The situation is scary. It is an outcome of past omissions and commissions, indiscriminate grant of loans without conducting due diligence, frequent use of banks for supporting fiscal profligacy of ruling political establishment besides economic slowdown which affected ability of companies to service the loans. Given the sheer magnitude of stressed assets, PSBs are indeed vulnerable to a point of eroding public confidence. What happens next?
The patient is on the operation table and the surgery must be performed. That will involve making all out efforts to recover the bad loans on one hand and tough actions to prevent fresh slippages on the other. Meanwhile, the patient has to get un-interrupted supply of oxygen and other support systems to ensure that he does not die.
Providing support systems or injection of fresh capital [using tax payers money] is the easiest thing to do. In this regard, the government has committed capital infusion of over Rs 200,000 crores; of this, Rs 70,000 crores will come by way of budget support in 4 years up to 2018-19 and Rs 130,000 crores from divestment of shares and internal resources [whether, this portion can be actually garnered is debatable].
As regards recovery of bad loans, finance minister has talked of empowering banks. But, existing laws are a huge bottleneck. Therefore, the government must vigorously pursue early passage of the proposed Bankruptcy Act and take opposition parties on board especially in view of BJP being in minority in Rajya Sabha. The law should be enacted in the budget session.
The task of galvanizing banks to prevent fresh slippages in the future is even more daunting. Herein, loan defaults on two counts need to be clearly differentiated. First, those which arise due to economic deceleration i.e. aspects on which individual borrower has no control. Modi – government is adequately addressing this and we already see revival. This will not only prevent fresh NPAs but also help in mitigating past NPAs caused by economic slump.
A second type of default is more worrisome. This has to do with political interference in the functioning of PSBs. In the past, a political-bureaucratic-industry nexus was at work and decisions in regard financing of projects were taken on considerations other than purely economic and commercial. No wonder, a number of such loans turned in to NPAs/stressed assets.
Will such interference and nexus end? Last year, Modi signalled this when he opined “henceforth, PSBs won’t get even a phone call from his office or any other ministry”. The government needs to walk the talk. It needs to put in place institutional mechanisms [including proper monitoring and surveillance] and ensure that managements get fully autonomy and are able to run them on professional lines.
In this regard, the P Nayak committee had recommended (i) setting up of an autonomous Bank Boards Bureau [BBB] with a mandate to select the top management and guide their operations; (ii) setting up of a bank investment company [BIC] where all government shares in PSBs will be vested and (iii) divestment of its shareholding in all PSBs to below 50% leading to relinquishment of management control.
Modi should vindicate his intent by implementing the committee’s recommendations. Without these structural changes, it will be hard to break the nexus that was nurtured for decades and has taken deep roots. In a scenario of business as usual [continued state ownership and control], the surgery alluded to by Rajan will be next to impossible.
Then, the government would have ended up throwing [rather wasting] more of tax payers money in re-capitalizing banks. In the future say, 5 years from now they will again come up with a big hole [read NPAs/stressed assets] to be filled with another round of capital infusion. The vicious cycle will continue.
Commenting on stock market crash, Jaitely has stated that “investors should not overreact; they should look at fundamentals of the economy which are sound and the situation will be under control soon”. His assurance will carry more conviction only if the government carries out major reforms in working of PSBs.