Recapitalization of State-Owned Banks: Privatization Should Do It

Context: India can fix its public-sector lenders by letting them raise enough equity capital to significantly reduce government control.

Key Concerns in the banking sector:

• Declining credit growth: fell from around 13% year-on-year in April 2019 to 6% in November 2020; due to rising risk aversion among lenders.
• Rising gross Non-Performing Asset (NPA) ratio: Financial stability report (FSR) stress test The FSR stress indicate rising NPA to the tune of 13.5% by September 2021.
  • NPAs in PSBs are expected to rise (16.1%), accounting for 60% of India’s total bank credit.
  • The low ratio of capital to risk-adjusted-assets (CRAR) (at 12%) is likely to decline further.

Issues with the privatization of PSBs: as recommended by an RBI internal working group (IWG)

1. High level of systemic risk to depositors: Raising the promoter share cap to 26% increases the risk in case of limited deposit insurance provided in India and low CRAR.
2. Excessive risk appetite would lead to imprudent lending.
3. Access to insider information on competing borrower companies would compromise competition.
4. Concentration of economic power and political influence against not just competing companies, but even the regulator.

Issue with the recapitalization of PSB’s: worth some Rs 2.5 trillion using partly taxpayer’s money and partly recapitalization bonds, including the discounted zero-coupon bonds sold to PSBs.

• No change in the ownership and governance structure of PSBs, causing poor performance.

Way forward:

• Simultaneous privatization and recapitalization of PSBs: The banks’ balance sheets are first cleaned up, and recapitalisation through fresh equity should reduce the government’s share below 50%.
  • It would recapitalize the banks, empowering them to resume lending, and simultaneously privatize their ownership structure, which would lead to improved performance.