Recapitalisation of public sector banks disappearing into quicksand: Ind-Ra

While the government has infused huge capital in public sector banks (PSBs), the funds have largely been used to mitigate losses and failed to contribute meaningfully to credit growth, according to India Ratings and Research (Ind-Ra).

The Fitch Group company said it is time to re-evaluate the objectives of PSBs and their role in Indian economy.

From 2013-14 to 2018-19, the government and Life Insurance Corporation (LIC) together infused Rs 3 lakh crore in PSBs. However, from the value creation objective, the scenario looks weak. The current market value as on July 29 this year of government and LIC's stake was Rs 4.4 lakh crore (FY14: about Rs 2.2 lakh crore).

"The increase in market capitalisation over FY14 is significantly lower than the capital infused. Nine of 19 PSBs reported current value of investment higher than the investment amount," said Ind-Ra. Among them are Indian Bank, State Bank of India, Bank of Baroda and Canara Bank.

The sharp deterioration in asset quality in the last few years led to accelerated provisions among all PSBs. This caused banks to suffer massive losses, which in turn led to failure in meeting objectives of the Indradhanush Scheme such as recapitalising banks based on their performance and their ability to support credit expansion.

"In reality, the capital infused was largely consumed to tide over losses resulting from provisions required on non-performing assets."

Over the years, the market share of PSBs in incremental credit generation shifted to other market participants including private banks, foreign banks, non-bank financial companies, housing finance companies and mutual funds.

The market share of PSBs fell to 46.5 per cent in FY19 from 60.9 per cent in FY14. More importantly, in terms of incremental credit, the share of PSBs has been 26.2 per cent over FY14-FY19.

The objective of nationalisation of banks included financial inclusion as the primary objective, along with increasing availability of credit to priority sectors such as agriculture and small and medium enterprises (SMEs).

Due to stress of bad corporate loans in the system, the incremental credit to agricultural and SMEs segments by PSBs has been only 1.3 to 1.5 times of incremental credit to agricultural and SME segment by top six private banks (by the size of its assets) -- that is significantly lower than the share of PSBs in the banking system.

Anecdotal evidence suggests PSB's share in funding direct small ticket lending to agri and other priority sectors still remains high.

"Recapitalisation is a prompt response to infuse funds in cash-strapped public sector banks. The capital infusion by the government in PSBs may ensure banks' solvency but may not necessarily ensure stability and growth in the absence of non-financial and structural reforms," said Ind-Ra.

Some the structural changes that Ind-Ra believes should be implemented at the earliest include increasing the tenure and preventing frequent changes in senior management team of PSBs as this does not allow for continuity in management policies and also reduces accountability.

Secondly, including variable compensation and granting employee stock options to directly link the performance of the bank with the performance of the management team. Thirdly, allowing appointment of candidates from the private sector. Some progress has been made towards this with the appointment of managing director and CEO for Bank of Baroda and more of this needs to be done to improve the management depth.

Fourthly, improving governance and increase independence of the board. Fifthly, capability building and introducing compensation programmes in the staff to bring their drive for business at par with private banks. And sixthly, using and adapting intelligent technologies to source business, manage loan workflows, reduce operating costs and reduce subjectivity in sanctions.

"Without structural reforms in place, the government will have to continue to inject capital into banks in times of stress, which will strain its own finances and hinder efforts for fiscal consolidation," said Ind-Ra.

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