Recapitalisation of PSU banks must be based on performance

Concerns about the health of public sector banks have been growing for some time now. A combination of factors over the past several years has contributed to a massive build-up of non-performing assets (NPAs), which, for banks, is the equivalent of an unstoppable bleeding wound. A significant reason for this burden is the massive exposures that these banks took to the infrastructure projects under the much-touted but now-condemned public private partnership (PPP) model. The government may be looking at alternative modes of financing infrastructure, but the legacy of the PPP model weighs heavily on the banks. As a result of this burden, they are extremely reluctant to take on any more risk. This has resulted in a sharp slowdown in commercial credit growth over the past year, at a time when the economy is showing some signs of recovery. A credit squeeze could well nip the recovery in the bud. From a long-term perspective, compliance with Basel III capital adequacy norms will require banks to enhance their equity capital by very large amounts if they are to sustain even a moderate growth in deposits and credit. However, the unstoppable bleeding sucks away capital, making the target even more difficult. Certainly, private investors will refuse to commit to this slippery slope. This leaves the government to infuse the necessary capital, which it will struggle to do in the current fiscal scenario. In short, this looks like a trap that it is going to be extremely difficult to get out of.

Of course, the government has made some allocations for recapitalisation, but at around Rs 8,000 crore, the amount is woefully inadequate, something that even the Reserve Bank of India has pointed out. The finance minister's reassurance that the recapitalisation will be done over the next few months does not constitute a solution at all, given the size of the allocation. Something drastic needs to be done to prevent a crisis, which, many observers believe, is already here.

First, there must be some cold, hard differentiation between banks. Last year, the government had announced a performance-based eligibility framework for recapitalisation, which it must now scrupulously adhere to. It is far more efficient to give more capital to each of a few relatively healthy banks than to spread it thin over all of them. Once this happens, the weaker ones will be forced to shrink their balance sheets, shifting business to the better run institutions. Second, the massive load of infrastructure NPAs must be lifted from the balance sheets of the banks. The proposed National Investment and Infrastructure Fund, announced in the Budget but yet to be operationalised, provides a possible way to do this. It would be a bailout, but this is now inevitable. Once freed of this, normal commercial credit flows will resume. Third, organisational and leadership reforms, for which proposals are already on the table, need to be pursued with determination and not just in a cosmetic way. The serious impact that a leadership vacuum can have is highlighted by the dramatic deterioration in the asset quality of Punjab National Bank, which has been headless since November. Meanwhile, the appointment process of several new chief executives is moving along at a leisurely pace. This just won't do.