Bank NPAs : Sudarshan Chakra Solution

The scale of the NPA problem at PSU banks is much larger than was thought, and the downturn in the Indian economy has also made the need for corrective measures more urgent

Issues related to NPAs in Public Sector Banks

The RBI’s asset quality review has revealed that the gross NPA ratio of both public and private sector banks is higher than was earlier thought

But in the PSU banks, it is alarming at about 12%

And this is an underestimate, because it does not include assets that are “stressed” but not yet NPAs

The Insolvency and Bankruptcy Code (IBC) is a major reform

Once an account is referred by a creditor under the IBC to the National Company Law Tribunal

And is admitted, the powers of the management and the board are transferred to an independent insolvency professional (IP)

The IP then looks for someone willing to take over the project on suitable terms

If no one is willing to take over, or the banks don’t accept the debt reduction implied by the package, the company is simply liquidated

The process changes the incentive structure facing bank managements by giving them a legally sanctified method of determining what is a reasonable haircut(haircut means cut in actual price of the project)

Since the alternative is liquidation, they(bank) should be willing to accept any haircut that gives them more than they would get from liquidation

The process will certainly clean up the books of the banks over the next 12 months or so

But it will also mean acceptance of large losses and a corresponding depletion of capital

In 2015, the finance ministry had estimated that the PSU banks needed Rs2.4 trillion of capital

Of this capital Rs1.1 trillion was to come from the market, Rs60,000 crore from retained profits, and the remaining Rs 70,000 crore from the budget

But this is clearly insufficient because the NPA situation has turned out to be much worse than expected

Fitch Ratings has estimated that Indian PSU banks will need as much as Rs4 trillion of capital by end of March 2019 to meet the capital requirements under Basel III

The scope for using public funds to recapitalize the PSU banks can only be judged on the basis of a holistic view of the many other demands for government expenditure

We cannot keep stimulate the economy through increased government expenditure

And without a clear view of how much of the capital requirement of the PSU banks has to be met from the budget

Reforms in PSU banks are expected to make the banks more efficient

The idea of merging PSBs, is not reform at all

Merging strong banks with other banks will do nothing to improve the average balance sheet

The most important reform will be to reduce the government’s equity to 33% in selected PSU banks

This would allow the stronger PSU banks to raise additional capital from the market, including from possible strategic investors(who could be offered seats on the board)

The inclusion of strategic investors, with representation on the board, may make it easier to raise capital without burdening the budget

If the budget is under stress, all PSBs need not be recapitalized to ensure targeted growth in lending.

Weak banks that have eroded their capital very substantially should be subjected to the RBI’s “prompt corrective action” discipline

This will allow healthier banks to expand and occupy the lending space created.