The Union budget for fiscal year 22 proposed to recapitalize public sector banks (PSBs) to ₹20,000 crore and set up a bad bank to remove toxic assets, two decisions that should improve the flow of credit.
Friday’s economic study suggested a clean-up of bank balance sheets as well as a subsequent recapitalization, with non-food credit growth remaining stable at around 5.1 to 6.7 percent between March 2020 and January 2021. Indian banks had to spend a lot of time recovering bad debts, estimated at 7.5% of all loans. Some of these were due to lax underwriting standards in the past, but many were actually affected by outside factors. A bad bank would take stressed assets off the books of banks, paving the way for cleaner balance sheets and faster collections.
“The high level of provisioning by public sector banks to their stressed assets calls for action to clean up the bank books,” Finance Minister Nirmala Sitharaman said in her budget speech. The idea, she said, is to take over the existing stressed debt, then manage and sell the assets to alternative investment funds (AIFs) and other potential investors.
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The idea of the bad bank has been around for some time. In 2018, a panel led by Sunil Mehta, then non-executive chairman of Punjab National Bank, suggested a five-pronged strategy for dealing with stressed assets, proposing an asset management company and an AIF for it. “Besides improving the reported financial statements, this will also free up management’s bandwidth to focus on core lending operations,” said Karthik Srinivasan, Group Head (Financial Sector Ratings) , ICRA Ltd.
There are global parallels to the bad bank’s path to cleaning up stressed assets. An often cited example is the Danaharta of Malayasia, created in 1998 to clean up a mountain of bad debts. To a lesser extent, the Indian government set up a Stressed Asset Stabilization Fund and segregated stressed assets from IDBI Ltd in 2004.
“The Indian Banking Association (IBA) had proposed the creation of a bad bank during the pandemic as the banking industry expected a rise in stressed assets,” said Rajkiran Rai G., CEO of Union Bank of India. on bad credit loans reduces provisioning requirements and improves the ability of banks to lend to productive sectors of the economy to spur growth, Rai said. The government appears to have taken note of the recent report on the RBI’s financial stability and the stress in the banking sector due to bad debts, according to Gaurav Dayal, partner, Lakshmikumaran & Sridharan Attorneys. The bad bank and the infusion of capital will clean up bank balance sheets and allow PSBs to meet regulatory standards, Dayal said. coming from the government as well as sponsoring banks. Allowing the participation of AIFs in the bad debt space is a welcome initiative and will only increase competition among bidders, ”he said.
The proposed capital injection of ₹20,000 crore in public lenders, although below market expectations, will strengthen their capital position and promote credit growth, provided demand also recovers. The government did not allocate recapitalization funds in the FY21 budget, but subsequently asked parliament to nod to infuse ₹20,000 crore thanks to an additional request for grants. So far, in FY21, the Center has injected ₹5500 crore of capital in PSB via special interest-free securities and another ₹4557 crore in IDBI Bank.
“The access of public banks to capital markets is currently limited. They collectively raised approximately $ 1 billion in equity between August and December 2020 in the capital markets, with banks having to settle for significantly lower amounts, even by their modest expectations, ”Fitch Ratings said in a note of January 31.
Fitch Ratings has warned that PSBs will be forced to continue down the path of risk aversion and loan growth on favorable terms without adequate financial support from the government.