Do public sector banks deserve a taxpayer bailout?

Jun 16, 2015

- By Vivek Kaul

Vivek Kaul
The finance minister Arun Jaitley said on June 12: "Banks have made a strong case for additional capital... And over the next few months, this is something the government is going to seriously look at." Jaitley was talking about the government owned public sector banks.

There are two questions that crop up here: a) do public sector banks deserve additional capital? b) can the government afford it? Let me first define the word capital and then answer the second question first.

As Anat Admati and Martin Hellwig write in The Bankers' New Clothes: "In the language of banking regulation, this word [i.e. capital] refers to the money that the bank has received from its shareholders or owners. This is to be distinguished from the money it has borrowed. Banks use both borrowed and unborrowed money to make their loans and other investments. Unborrowed money is the money that a bank has obtained from its owners if it is a private bank or from its shareholders if it is a corporation, along with any profits it has retained."

In case of public sector banks, the government is the biggest shareholder and any capital infusion would mean the government investing more money in these banks. How much money does the government need to infuse in these banks? In a research note titled A Growing Need for Indian TARP, Anil Agarwal, Sumeet Kariwala and Subramanian Iyer,analysts at Morgan Stanley estimate that an immediate infusion of around $15 billion (or Rs 96,000 crore assuming $1 = Rs 64) is needed in these banks. And that is clearly a lot of money for the government to spend in a single year. The budget for 2015-2016 provided Rs 11,200 crore towards fresh capital infusion by the government in public sector banks.

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The PJ Nayak committee report released in May 2014, estimated that between January 2014 and March 2018 "public sector banks would need Rs. 5.87 lakh crores of tier-I capital." The report further points out that "assuming that the Government puts in 60 per cent (though it will be challenging to raise the remaining 40 per cent from the capital markets), the Government would need to invest over Rs. 3.50 lakh crores."

It is safe to say that the government clearly does not have the kind of money that is needed to be invested in public sector banks. Now let's try and answer the first question which is, whether the public sector banks deserve this kind of money to be invested in them by the government.

On the face of it, the answer is yes, simply because that public sector banks carry out nearly 70% of lending in India. And if they are not adequately capitalized, they will not be able to lend as freely as they may want to and as may be needed.

But there is more to it than just that. As the Morgan Stanley analysts point out: "The current managements' policy of "extend and pretend" is causing banks to move further into problems." What do they mean by extend and pretend? Crisil Research estimates that 40% of the loans restructured during 2011-2014 have become bad loans.

A restructured loan is where the borrower has been allowed easier terms to repay the loan (which also entails some loss for the bank) by increasing the tenure of the loan or lowering the interest rate. If 40% of restructured loans have gone bad, it is safe to say that the banks have been essentially restructuring loans in order to postpone recognizing them as bad loans, which is what the Morgan Stanley analysts meant by "extend and pretend".

Interestingly, bad loans are expected to go up during this course of the year primarily because more and more restructured loans will turn into bad loans. The Morgan Stanley analysts expect nearly 65% of restructured loans to turn into bad loans.

Further, as Crisil Research points out in a research note titled Modified Expectations: "Reported gross non performing assets [bad loans] will still remain at elevated levels as some of the assets restructured in the previous 2-3 years, especially in the infrastructure, construction, and textiles sectors, degenerate into non-performing assets again."

Also, as Debashis Basu points out in a column in the Business Standard, that other than an increase in bad loans, "the continued evergreening of bad accounts - and, what is worse, the continued dubious new lending by public sector banks, with minimal collateral, arranged by touts," continues to remain a worry.

In this scenario there is no point in the government putting in more hard-earned money of taxpayers into these banks. Until, Jaitley's statement on June 12, the government's stand was that additional capital would be put into public sector banks only after they improve the governance structure of public sector banks. The irony is that some of the biggest public sector banks have not had a CEO for many months now.

It had also asked the banks to reduce government stake to up to 52% and raise money directly from the stock market. But given the weak balance sheets of many of these banks, this option really does not exist.

To conclude, it is worth asking, why does the government of India need to own 26 public sector banks, especially in a scenario where many of these banks will require a lot of money to be invested in the next few years?

The best bet for the government is to go in for "strategic disinvestment" of most of these banks. Given their distribution network they may be good bets for the private sector. Further, the government can continue to own the State Bank of India and probably four other best public sector banks, in order to ensure that it is able to push through its financial inclusion programmes.

Vivek Kaul is the Editor of the Diary and The Vivek Kaul Letter. Vivek is a writer who has worked at senior positions with the Daily News and Analysis (DNA) and The Economic Times, in the past. He is the author of the Easy Money trilogy. The latest book in the trilogy Easy Money: The Greatest Ponzi Scheme Ever and How It Is Set to Destroy the Global Financial System was published in March 2015. The books were bestsellers on Amazon. His writing has also appeared in The Times of India, The Hindu, The Hindu Business Line, Business World, Business Today, India Today, Business Standard, Forbes India, Deccan Chronicle, The Asian Age, Mutual Fund Insight, Wealth Insight, Swarajya, Bangalore Mirror among others.

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12 Responses to "Do public sector banks deserve a taxpayer bailout?"

kailash chandra sarangi

Aug 25, 2015

Govt should amalgamate the banks to have 5 to 6 banks of SBI size and then capitalise.


ashok soni

Jun 25, 2015 this phase has come after a very long gap of time.Infusion does not mean a revenue expenditure but a capital investment.As the banks have to maintain capital adequecy ratio is to some extent for n.p.a accumulation.psbanks provide help to the govt thru dividends.The bank may startfastefforts to reduce n.p.a.Proper strict monitoring of credit with special vigilent method & fixing accountability sure can reduce n
P.a.level.Infussion of capital may b the cause of 2008 depression effect.If bankers r impartialin disburesement of credit n pressure from high level with accountability surely reduces NPA's.


Ashok Golas

Jun 20, 2015

It would be best to merge weaker PSU banks with stronger ones and leave them to the market forces to enhance their capital. This charade of public funds being given without any real control would be fraud on the people of India. This charade of throwing away public funds into PSUs has gone on too long and should be stopped forthwith



Jun 19, 2015

Yes public sector banks certainly deserve to be bailed out but on the MLA & MP's personal funds since these are the very same people who pressurize the banks to keeps lending to the sectors where the NPA's are rising without worring about the recovery of the amount loaned. This Political Builder nexus must be brought to an end. Today any TOM, DICK & HARRY is a builder with the Blessing of Politicians and not with the Blessing of GOD



Jun 17, 2015

While I agree with most of comments made in the article and also agree with the suggestion of disinvestment and exit from most of these banks by the Government of India as well as retaining SBI and one or two other Banks, the article has not mentioned the political decisions implemented through these Banks which is one of the main reasons for their current sickness.


Shrinivas Moghe

Jun 16, 2015

The days are gone, when a borrower takes a loan with a dubious intention. This is true with SME sector, in particular. The new generation borrowers are mostly qualified persons, and are driven by motive to prove them self. So, when such a borrower fails to repay the debts, banks should have a mechanism to first identify the cause, before restructuring the loan. Many times, the cause lies else where. Mere financial aid may not help. The depressed borrower, usually fails to identify his real need, and borrows more, but gets caught in the vicious circle, eventually. This is the reason that we seldom see restructured loans serving the purpose.



Jun 16, 2015

Inducting capital is not the solutions. This is a burden on honest people by dishonest peoples. Quality of assets are very low because of
1. Lack of professionalism
2. Cooked balance sheets by borrowers
3. Vested interest in granting loans and settlement of bad debts.
4. There is total lack of transparency in appraisals. People deserve for 40-45 marks are getting 90+ and who worked hard are thrown out in depression.
5. There is no mechanism to enforce law. DRT,s are delaying the matters for years.
6. Some people whose records are not good continuously appointed here and there. The new generation is not being allowed to take over

Like (1)


Jun 16, 2015

youe suggestion to divest and hold just 4 or 5 as PSU Banks makes lot of sense;As said it is simple but not Easy;Unionised employees of PSU Banks ,and Vote bank politics will not allow this take that.

Like (1)


Jun 16, 2015

Your suggestion is true and practical.But will it happen.Even govt is not thinking about it.Even if they have the idea the opposition and employees will not allow it.When it is for the benefit for advancement of our country these sort of obstacle are always there to tackle.When all these things will disappear i do not know.

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Jun 16, 2015

It will be Kazaization of Public sector Bank at the cost of 'Great India', for the benefits of private hands, giving a support hand for the whites.

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