India's Big Govt is the Main Problem of Public Sector Banks: Recapitalisation, Doesn't Solve That - Vivek Kaul's Diary
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India's Big Govt is the Main Problem of Public Sector Banks: Recapitalisation, Doesn't Solve That

Oct 25, 2017

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One of the examples of Big Government I have in my book India's Big Government is that of government owned public sector banks. (The good news is that the book is available at a huge discount on Amazon till Friday, 27th October. The Kindle version is going at Rs 199, against a maximum retail price of Rs 749, and the paperback is going at Rs 499, against a maximum retail price of Rs 999).

When I wrote the book, the Indian government owned 27 public sector banks. As of April 1, 2017, the Bhartiya Mahila Bank and the five associate banks of State Bank of India, were merged with the State Bank of India. Due to this merger, the number of government owned banks fell to 21. This merger has pulled down the overall performance of the State Bank of India and is just a way of sweeping problems under the carpet. Over the years, the government plans to use mergers to reduce the number of banks it owns to anywhere between ten to fifteen. This as I have said in the past is a bad idea.

Yesterday afternoon, the finance ministry announced a plan to invest more capital in public sector banks, which are saddled with a massive amount of bad loans and restructured loans. The government plans to put in Rs 2,11,000 crore over the next two years, "with maximum allocation in the current year".

Where will this money come from? Rs 18,139 crore has been allocated from the current financial year's budget. Banks are expected to raise capital by issuing new shares. This is expected to raise around Rs 58,000 crore.

This leaves us with around Rs 1,35,000 crore. Where will this money come from? This money is expected to come in through recapitalisation bonds. How will this work? The government hasn't specified the details of how these bonds will be issued. (This makes me wonder as to why have a press conference in the first place, when the most important part of the plan, has not been decided on).

From what I could gather speaking to people who understand such things, this is how it is supposed to work. The banks have a lot of liquidity because of all the money that has come in because of demonetisation. A part of these deposits will be used by public sector banks to buy recapitalisation bonds issued by the government.

The money that the government thus gets will be used to buy fresh shares that the banks will issue. Thus, the banks will be recapitalised.

Now on the face of it, this sounds like a brilliant plan, where money is moved from one part of the balance sheet to another and a huge problem is solved. But is it as simple as that?

a) By issuing recapitalisation bonds the debt of the government will go up. Over and above this, interest will have to be paid on these bonds. Both the debt and the interest will add to the fiscal deficit of the government.

b) Given that the debt of the government will go up, this would mean that the taxpayers will ultimately pick up the tab because the debt will have to be repaid. It makes sense to always remember that there is no free lunch in economics. The corollary to this is that there is no free lunch especially when something feels like a free lunch. Of course, the taxpayers aren't organised and hence, they are unlikely to protest. And given that they finance all bailouts.

c) It remains to be seen what the banks do with this extra capital. Will they use it to write off restructured loans of corporates? Will this dull their enthusiasm (not that they had enough of it in the first place) to recover bad loans? As the situation changes, so will the behaviour of bankers.

This will also bring to the fore the issue of moral hazard. And what is moral hazard? As Mohamed A El-Erian writes in The Only Game in Town: "[It] is the inclination to take more risk because of the perceived backing of an effective and decisive insurance mechanism." If the government bails them around this time around, the banks know that they can count on the government bailing them out the next time around as well. And this means that they can follow fairly loose standards of lending, in order to lend money quickly.

d) As I keep saying, bank lending among other things is also a function of whether there is demand for such lending. The public sector banks have gone slow on lending to corporates (in fact they have contracted their loan book) because of a lack of capital. Or so we are told. But this lack of capital doesn't seem to have hindered their lending to the retail segment. Now that they will have access to more capital, will this reluctance to lend to corporates go away? I am not so sure.

e) Also, some of the banks are in such a bad state, that they really don't deserve this capital. They shouldn't be in the business of banking in the first place. Take a look at Table 1. Table 1, lists out the bad loans ratio of all the public sector banks. Bad loans are essentially loans in which the repayment from a borrower has been due for 90 days or more.

Table 1:
Name of the bankBad loans ratio (in per cent)
IDBI Bank24.11
Indian Overseas Bank23.6
UCO Bank19.87
Bank of Maharashtra18.59
Central Bank of India18.23
Dena Bank17.37
United Bank of India17.17
Corporation Bank15.49
Oriental Bank of Commerce14.83
Allahabad Bank13.85
Punjab National Bank13.66
Andhra Bank13.33
Bank of India13.05
Union Bank of India12.63
Bank of Baroda11.4
Punjab and Sind Bank11.33
Canara Bank10.56
State Bank of India9.97
Syndicate Bank9.96
Vijaya Bank7.3
Indian bank7.21
Source: www.careratings.com

As can be seen from Table 1, only two public sector banks have a bad loans ratio significantly lower than 10 per cent (Actually its four, but State Bank of India and Syndicate Bank are very close to 10 per cent).

Eight out of the 21 banks have a bad loans ratio of greater than 15 per cent. This basically means that out of every Rs 100 of lending carried out by these banks, at least Rs 15 is no longer being repaid.

Some of these banks with extremely high bad loans are way too small to make any difference in the overall lending carried out by banks. Take a look at Table 2.

Table 2:
Name of the BankTotal advances as a percentage of gross advances of banks (as on March 31, 2017)Bad loans rate (as on June 30, 2017)
United Bank of India 0.82%17.17%
Dena Bank0.90%17.37%
Bank of Maharashtra1.18%18.59%
UCO Bank 1.48%19.87%
Central Bank of India1.73%18.23%
Indian Overseas Bank 1.74%23.60%
Source: Author calculations on Indian Banks' Association data and www.careratings.com

These public sector banks have now reached a stage wherein there is no point in the government trying to spend time and money, in reviving them. It simply makes more sense to shut them down and sell their assets piece by piece or to sell them, lock, stock and barrel, if any of the bigger private banks or any other private firms, are willing to buy them. But what the government is doing instead is using taxpayer money to maintain its control over banks.

f) Also, recapitalising banks does not take care of the basic problem at the heart of public sector banks, which is that they are public sector banks. Allow me to explain. Let's take the example of the State Bank of India, the largest public sector banks. As of June 30, 2017, the bad loans ratio of the bank when it came to retail lending was 1.56 per cent. At the same time, the bad loans ratio when it came to corporate lending was 18.61per cent.This basically means that State Bank of India, does a terrific job at retail lending but really screws up when it comes to lending to industry. What is happening here? Thomas Sowell, an American economist turned political philosopher, discusses the concept of separation of knowledge and power, in his book Wealth, Poverty and Politics.

How does it apply in this context? In public sector banks, managers who have the knowledge to take the right decisions may not always have the power to do so. Take the case of retail lending. The manager looks at the ability of the borrower to repay a loan, and then decides to commission or not commission one. This explains why the bad loans ratio in case of retail lending is as low as 1.56 per cent (in fact, it was just 0.55 per cent before the merger). A proper process to give a loan is being followed in this case.

But when it comes to lending to corporates, there are people out there (or at least used to be) who are trying to influence the manager's decision; from bureaucrats to ministers to politicians. In this scenario, the manager ends up giving out loans even to those corporates who do not have the wherewithal to repay it.

The separation between knowledge and power has led to a situation where bank loans were given to many crony capitalists who have defaulted, and what we are seeing now is a fall out of that. In many cases, the corporates have simply siphoned off the loan amounts by over declaring the cost of the projects they borrowed against.

Of course, as long public sector banks continue to remain public sector banks, this risk will remain. But this government (and the ones before it) likes the idea of owning banks, and because it gives some relevance to ministers and bureaucrats.

Also, the employee unions of public sector banks have a huge nuisance value. No government has had the balls to take them on, in the past. Neither does this one. And this basically means that taxpayers will have to continue rescuing the public sector banks.

Vivek Kaul is the Editor of the Diary. He is the author of the Easy Money trilogy. The books were bestsellers on Amazon. His latest book is India's Big Government - The Intrusive State and How It is Hurting Us.

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11 Responses to "India's Big Govt is the Main Problem of Public Sector Banks: Recapitalisation, Doesn't Solve That"

Baskaran

Nov 4, 2017

Vivek, I request you to please ponder over the following :

1. Moral hazard : what do you expect if one of the large Private sector Bank lime Axis or ICICI. run into serious scams and losses as happened with North Rock, Barclays, RBS, Lloyds of UK in 2008 ( when UK Govt was forced into pump huge money into these Banks) or Goldman Sachs, Citi , Morgan Stanley of USA. The lesson in financial sector mess happen periodically as the smart MBA crooks who run it get away while the regutors learn costly lessons.

2. I fully agree with you on Govt. . control on decision making, CMD appointments Board appointments and even promotion of senior executives etc. The solution is operational autonomy. It is a moot question as to whether any politician, Beaurocrat will like to relinquish it. Bring the govt. holding to less than 25%.

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Hemant

Oct 29, 2017

Dear Vivekji,
firstly nice articular and good explanation of banking.
Hopping all it works in positive direction in coming diced.

i have a question
1) Can it all happened due to the old govt decisions ?
2) Can corruption plays any role in history ?

As there is huge difference in earnings of high class and middle class group, and may restructuring of banks can helpful for them...
Thanks & Regd,
Hemant...

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Sarat Palat

Oct 28, 2017

Now- a -days while reading the mails from Mr. Vivek Kaul, I had a doubt that whether he is using this column to sell his books.

Like (1)

Harminder Singh Sidhu

Oct 28, 2017

Author should visit a rural or semi urban branch of a PSU bank and then rethink. Has India reach a stage where it can privatize psu banks? Do you think private banks will provide KCC to poor farmers, MUDRA loans to micro entreprises? Will a private bank open savings accounts just to disburse widow pensions, old age pensions and scholorships where minimum balance is 10000? Will a private bank open branches in far flung places where there is no business potential? Above all do people in India have the capacity to pay the exorbitant charges of private banks?

The root cause is "political interference" while disbursing corporate loans. Currently top 12 NPAs account for 25% of total bad debt. Corruption and poor resolution mechanism is what needs to be addressed.

And as far as bank unions are concerned, they are toothless tigers. Govt doesnt give a shit to what they say or do.

Like (1)

Vijay Malhotra

Oct 27, 2017

Dear Sh. Vivek, You are doing a yeoman service, but for whom ? For those whose voice have no say or shall I say they do not let their say be mattered when the time to vote comes. India living in villages and slums/ basties or small towns do not read your articles, so the scope is very limited. Anyway you keep on doing this good job atleast.

The whole exercise/should I say 'game plan' of Recapitalisation is to swindle away this money as has been happening in the past. The list of big fish is well known to Indians who are the main participants in the NPAs. So sooner such players will once again be on the prowl to make the best of this so called exercise.

Sorry to see the rise in the prices of PSU banks on the share market. All those buyers will loose money once the reality is out. God Bless this Nation: heading into nowhere.

Like (1)

S K LIMAYE

Oct 26, 2017

Sir , you have hit the nail on the head - very precisely ! Why only PSBs ? Even other PSUs are used and abused like that by these people. But there is another dimension.In case of retail borrowers the manager is not getting any ' kickback ' and hence goes my rules , at times too strictly . But in cases of corporate loans he knows that ultimately he has to sanction when someone would fire placing gun on his shoulders so why not make something for himself by being nice and ' friendly ' in the first place !

Like (1)

B B Raina

Oct 25, 2017

Dear Sir,

Nice well researched article as ever. But my point is: Is the impugned Manager really that powerless that he cannot say NO to a corporate client on his loan request. So this gentleman Thomas Sowell, an American economist turned political philosopher, who has discussed the concept of separation of knowledge and power, in his book Wealth, Poverty and Politics, I would request you to write on Professional Integrity of a Powerless, Knowledgeable Manager who can and must say NO when it has to be, come what be. He is after all a custodian of our(the taxpayers') money.
Rgds
B B Raina

Like (1)

KIRAN KUMAR SHARMA

Oct 25, 2017

Dear Vivekji ,
It is extremely good and good for readers too . You must keep on writing . I am an ordinary man and living in a small village . I have three question in my mind , if you can spare time to explain them .
1. Is there any solution with the ruling party or with the opposition to solve the problem ?
2. Really is there any solution in near future ?
3 Majority of population lives in village . Can they understand in which direction they are going on ? Although they have power of votes .
THANKYOU ,
With regards ,
K K SHARMA
( KIRAN KUMAR SHARMA )
DATED : 25/10/ 2017

Like (1)

Nitin Raheja

Oct 25, 2017

This whole bank recapitalisation issue, really interesting if I have understood correctly, firstly the banks would take the existing tax payers money which is lying as deposits in their books and subscribe to Govt bonds, then the Govt would subscribe to equity thereby shoring up the net worth and capital adequacy of these banks, so for banks and Govt it is a cash neutral event. What it does it gives the banks a ability to borrow more from the markets and lend. So tax payers deposits have been used to recapitalise the banks. More important questions what about issues such as accountability, the same banks who have due to lax systems and coterie politics lend loans which went bad are being given an ability to take more deposits from tax payers and lend more to the same group of people. Its like giving a bad performing fund manager more money to manage. Secondly we are in a situation where deposits as a destination of investment are coming down given the low yield that they present and more move towards mutual funds, in such a scenario and also with their reputations considerably tarnished raises a question mark on their ability to even raise deposits aggressively to participate in the credit growth and maintain their market share.

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Varghese. V

Oct 25, 2017

Who will bell the CAT? Poor tax payer is unable to question his own government. What a nonsense is our Democracy?

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