CII suggests a 6 Point Agenda to the Government to further recapitalize the Public Sector Banks (PSBs). A prudent combination of any or all these recommendations will go a long way in easing the PSBs of the NPA overhang by infusing capital and creating the necessary momentum for credit growth in the economy.

1. Bank Recapitalization: Reviving Investments 1
Bank Recapitalization:
Reviving Investments
November 2017

3. Bank Recapitalization: Reviving Investments 1
Bank Recapitalization: Reviving Investments
India’s banking sector includes different types of banks - scheduled commercial
banks (SCBs), regional rural banks, and cooperative banks - and is dominated
by public sector banks (PSBs) where majority stake is under Government
ownership. While the share of PSBs in deposits and advances has been coming
down in total SCBs, these banks still account for around 70% of advances
and assets and almost three-quarters of deposits of all SCBs.
Need for bank recapitalization
The Reserve Bank of India in its Fourth Bi-Monthly Monetary Policy Statement
of 4 October 2017 has noted, “Recapitalizing public sector banks adequately
will ensure that credit flows to the productive sectors are not impeded and
growth impulses not restrained.” Recapitalization of PSBs has emerged as an
increasingly urgent measure due to the following key reasons:
High stressed assets
PSBs are suffering from high non-performing and stressed assets as a
proportion of their total assets. The stressed assets ratios for public sector
banks as of March 2017 was close to 16%. In private sector banks, this
ratio stood at just over 4%. Gross NPA ratio crossed 12% for PSBs and
remained below 4% for private sector banks1
. In the last two years, stringent
requirements by the Reserve Bank of India for identifying and addressing
stressed assets under its Asset Quality Review from April 1, 2015 have
uncovered the financial situation of PSBs, and total stressed assets went up
by 135% from Rs 2.6 lakh crores to Rs 7 lakh crores. A higher capital base
is a must for banks to surmount this crisis, along with the various measures
being taken to resolve NPAs.
1 Speech by Viral Acharya, Deputy Governor, RBI, on Sep 7, 2017

4. 2 Bank Recapitalization: Reviving Investments
Gross NPAs and Stressed Advances to Total Advances (%)
Source: RBI Financial Stability Report Stressed advances are sum of Gross NPAs
and Restructured Standard Advances
4.6
5.1
7.8
9.2
9.6
11.1 11.3 11.5
12.3 12.0
0
2
4
6
8
10
12
14
Mar'15 Sep'15 Mar'16 Sep'16 Mar'17
Gross NPAs Stressed Advances
Financing growth
PSBs are required to finance growth, including that of the priority sector which
extends to agriculture sector, micro, small and medium enterprises, self-help
groups, and various Government programs. The Indian infrastructure sector
alone is expected to require Rs 31 lakh crore of investment over 2016-20,
with power, roads and urban infrastructure accounting for 70%. About half
of this is expected to be raised from banks.2
This task requires a growing capital base of PSBs. However, PSBs credit
growth has slowed down drastically, indicating their unhealthy financial
situation. Growth in PSBs advances has plunged from almost 25% in 2007-08
to a bare 1% in 2016-17. It may not be possible to revive the credit pipeline
unless banks build up their capital assets.3
2 CII-CRISIL Report ‘Building India through a Stronger Financial System’ May 2016
3 Speech by Dr Viral Acharya, Deputy Governor, RBI, on Sep 7, 2017

5. Bank Recapitalization: Reviving Investments 3
On 24 October 2017, Ministry of Finance announced Recapitalization package
of INR 2.11 lakh crores for the stressed Public Sector Banks. INR 1.35 lakh
crores wold be generated from sale of Recapitalization Bonds and remaining
INR 76000 crores through budgetary allocation and fund raising from the
markets. The Total stressed assets in the Indian Banking System is close
to INR 10 lakh crores out of which gross Non-performing Assets (NPAs)
account for INR 7.7 lakh crore and rest are restructured loans.
Regulatory requirements
Regulatory norms arising from the Basel process necessitate PSBs to raise
their capital adequacy ratio. Under Basel III agreement in 2010, the capital
to risk-weighted assets ratio (CRAR) where capital includes Tier-I, common
equity tier-I (CET-I) and Tier-II capital, should stand at minimum 8% by
2019. The Reserve Bank of India has gone beyond this to set the bar at 9%
plus 2.25% capital conservation buffer (CCB) to reach a minimum capital
requirement of 11.50% by 2019, an extension from the earlier target of 2018.
The CII-CRISIL report ‘Building India through a Stronger Financial System’
estimates that PSBs total capital needed to meet the regulatory norms would
stand at Rs 2.6 lakh crores.
Other reasons
New accounting standards, Ind AS, will be applicable for banks from April
1, 2018. This is likely to increase provisioning requirements on bad loans by
as much as 30%, further adding to PSBs capital requirements.4
PSBs further require capital infusion on account of their low performance in
return on assets and return on equity. Both have been continuously sliding
since 2010-11 and in 2015-16, both data points for PSBs were in negative
territory. There is a danger of erosion of capital if the situation continues.
4 https://www.outlookindia.com/newsscroll/indas-migration-to-raise-banks-capital-need-by-30-
mundra/1083171

6. 4 Bank Recapitalization: Reviving Investments
Capital requirements
Currently, PSBs are majority-owned by Government with a minimum stake
of 58% which has now been relaxed to 52%. However, many PSBs have
a much higher Government equity holding at over 80%, while only 4 have
brought down the share to 58% as of March 2017. In addition, LIC of India
owns a substantial share of the remaining equity. In most cases, stake owned
by others is less than 20%.5
While Basel-III requirements alone add up to Rs 2.6 lakh crore, the Government
in December 2014 pledged Rs 70,000 crores to be provided from 2016-2019
to meet this requirement. In August 2015, PSBs were tasked to raise Rs 1.1
lakh crore from the market by 2018-19; however, only Rs 7,726 crores has
been raised till March 2017. Since then, the real situation regarding poor
asset quality of banks has been revealed at close to Rs 7 lakh crores. The
urgency of bank recapitalization is intensifying as the investment pipeline is
held up, with notable impact on growth. While boosting economic growth
pace would also require encouraging overall demand and boosting investor
sentiments, the role of bank recapitalization cannot be understated at this
point in time.
5 Comptroller and Auditor General of India, Report 28 of 2017, ‘Performance Audit Union
Government Recapitalization of Public Sector’

7. Bank Recapitalization: Reviving Investments 5
Recommendations
1. Lower Government stake
PSBs should be encouraged to go for public issue and use this capital to
write-off debt. This will increase their equity capital. As a quick measure,
whatever margin is available to them over 52% may be liquidated in the
capital market.
Over the next 2-3 years, the Government should consider bringing down
its stake in most PSBs to 33%. It could retain a larger share in the State
Bank of India in order to meet priority needs. However, smaller banks
that are in poor condition require to be managed with greater efficiency.
One challenge in offloading shares could be the poor return on assets
and equity that currently characterize some PSBs.
PSBs can look at issuing preference shares instead of equity shares to
maintain the majority voting rights and control within the Government
without transferring the same to the investors.
Reducing Government shareholding in banks need not lead to loss of
control as there are enough measures in place to avoid concentration of
shareholdings with other entities and to ensure broad-based ownership.
Policies on priority sector lending, export credit, and so on will guide
PSBs as well.
Divestment helps in two ways: to raise required funds; and to make
PSBs more accountable, reduce government participation in management,
inculcate transparency, and help in achieving employee pay parity with
private sector banks and eventually make them more efficient.

8. 6 Bank Recapitalization: Reviving Investments
2. Infrastructure Debt Funds
The infrastructure sector is a major source of bad assets for PSBs,
and there is a mismatch between the relatively short-term nature of
bank assets and the long-term tenure of infrastructure loans. A viable
option for addressing this mismatch is required. Thus, banks may look
at re-financing their infrastructure portfolio through Infrastructure Debt
Funds. These are investment vehicles where institutional investors such
as insurance and pension funds can invest and refinance existing debt of
infrastructure companies. Offloading such advances disbursed to successful
infrastructure projects could open up space for new credit growth.
3. Recapitalization bonds
The Government has made necessary announcements by proposing to
issue recapitalization bonds to the tune of INR 1.35 lakh crores. Details
on the methodology to be adopted for issuance of bonds is awaited. CII
unequivocally supports this move and feels that such measures bode well
for the overall growth of the Indian economy.
The Government can also alternately look at allowing banks to re-issue
these bonds to the general public. These bonds have de-facto sovereign
guarantee. This will enable the banks to raise the necessary funds.
Rationale: This could lead to additional inflow of money for
banks.
Step 1: Government issues bonds to Banks and banks pay a certain
amount to the Government for the same.
Step 2: Government uses these proceeds to buy shares of banks
through rights issue and banks get the necessary capital.
Step 3: Now the banks, who are the holders of these bonds, issue
the same to the general public and mobilise the necessary funds.

9. Bank Recapitalization: Reviving Investments 7
Potential buyers of such bonds could be pension funds, insurance
companies, other institutional investors, both globally and locally, and
retail investors.
4. Securitization of loan portfolio
Securitization of good/ performing loan portfolio and selling the units
to investors may enable PSBs to raise funds to capitalize their books.
5. Higher Government support
The Government under the budgetary support has announced an additional
infusion of INR 18,139 crores.
Considering the increase in tax collected as a percentage of GDP post
demonetization and implementation of GST, the Government may consider
further increasing the amount allocated to the Indradhanush scheme to
capitalize PSBs through the collected surplus.
6. Bank holding company
A Bank Holding Company may be considered. Such a company could
assume the entire Government stake in all PSBs. It would be empowered
to raise resources from various sources and issue bonds, and would also
monitor bank performance.
Such a holding company may also be directed to take over certain stressed
assets so that PSBs lending capacity is not impaired, and these may be
resolved by it.

10. Notes:

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