Public sector banks: Troubles continue

The Mahapatra Committee recommendations could erode a large portion of public sector banks? net worth

Public sector banks are in trouble and have betrayed this fact by objecting to the recommendations made by Reserve Bank of India’s committee on loan restructuring. The Mahapatra Committee set up by the central bank had suggested the abolition of regulatory forbearance while recasting debt after two years. If implemented, this would mean that all restructured loans will have to be classified as NPAs (non-performing assets).

Credit rating agency Crisil has revised its loan recast figure to Rs 3.25 lakh crore for 2012-13 which is a sharp rise from Rs 2.18 lakh crore for 2011-12. Nearly 80 per cent of these loans are in the books of public sector banks.

To get a perspective of the size of NPAs, as per data collected by Business Standard Research Bureau, the consolidated net profit of all listed public sector banks in FY12 was only Rs 53,000 crore, and the total net worth of all these banks together was Rs 3.53 lakh crore. Thus, if these recasting of debt has the potential of wiping out a large chunk of the banks’ net worth.

No wonder, banks are rejecting RBI’s suggestion as providing for NPAs would not only reduce their profit but the provisioning would also hit their balance sheets. If the banks post losses they will have to transfer it to the net worth in the balance sheet which would then be eroded to the extent of these losses. In other words Tier-1 capital of the banks will get affected, thus impacting their ratings and their ability to borrow and lend. Banks would then need to raise capital for which they would have to go to the government. But the government itself does not have funds and has relied upon Life Insurance Corporation to pump in capital in many of the smaller public sector banks last year.

Logically, the committee recommendations are correct as any loan goes for a recast when the borrower is unable to pay even the interest component for three months in a row. Obviously, it indicates that business prospects have worsened and the borrower is barely surviving. A further deterioration would result in downsizing or closure of the business. In such a case, banks “evergreen” these loans by sweetening the tenure.

A large portion of loans of the public sector banks are from state electricity boards and other public sector enterprises, which generally have the guarantee of state governments or central government.

It is unlikely that the recommendation will be followed by the banks or pushed by the government as they will be the ones picking up the tab. But these numbers reveal the fact that the foundations of our banking system could be on the verge of collapse, unless drastic steps are taken.