The crisis in public sector banks

Under pressure from RBI, they have presented a true picture of losses. It is now up to the government

Several thoughts arise when we look at the horrific results declared by banks in this quarter. At one level, it is simply appalling that mismanagement and political interference allowed things to get this bad. The second thought is relief that this problem is now being acknowledged, along with hope that it might be dealt with.

There hasn't yet been a "Lehman moment", to quote Dr Rajan, and with luck a full-blown crisis can be avoided. Public sector banks (PSBs) can be recapitalised. Poor management can be overhauled. Due-diligence and loan assessment systems can also be revitalised. If, political interference is reduced, the system could emerge stronger. Of course, that's a lot of 'ifs'.

The Reserve Bank of India (RBI)'s insistence that bad loans be recognised and provisioned for has meant declaring massive losses for most PSBs. As of now, it does not seem that the private sector banks will need to recapitalise and shore up net worth immediately, though all banks must raise cash to fulfil Basel III norms. The PSBs have much higher recapitalising needs, too.

The levels of non-performing assets (NPAs) are mind-boggling. The banking sector as a whole has seen gross NPAs rising by over 80 per cent since March 2015. Gross NPAs are defined as loans that have seen delays of at least three months in terms of payment of principal or interest. Net NPAs, meaning NPAs that are not provisioned for, have roughly doubled in the same time.

On a quarter-on-quarter basis, net and gross NPAs are up by roughly a third since October-December 2015 for the banks that have declared results. As of now, gross NPAs equal about Rs 2.8 lakh crore, with State Bank of India yet to declare results at the time of writing. Net NPAs are Rs 1.64 lakh crore. This means uncovered losses amount to roughly 1.25 per cent of Gross Domestic Product (GDP).

The biggest NPAs are in the energy sector and in iron and steel. The latter industry has been hit by collapsing global commodity prices and low demand. The former has been hit by, among other things, the refusal of various states to set power rates at reasonable levels. Schemes like UDAY (Ujjwal Discom Assurance Yojana), which convert dues of state-run distribution companies into bonds issued by states (with implicit sovereign guarantees), will paper over some losses. The Punjab government is trying to negotiate a similar scheme to write off Rs 20,000 crore it owes banks for procurement of foodgrains.

There hasn't been much pick-up in industrial activity either, going by the Index of Industrial Production across 2015-16. This probably means more loans going sour. RBI has asked banks to provision for 15 per cent losses on strategic debt restructuring and that could be an under-estimate in terms of likely SDR losses.

RBI has set FY 2016-17 as the year when NPAs are to be wiped off the books. That could mean a few more quarters of terrible results. At the end of this cyclone, we will have a clearer picture of how much balance sheet recapitalisation is required.

If the PSBs are to meet Basel-III norms, huge sums will be required. The timeline for Basel-III is 2018-19, also an election year. The bill for PSB recapitalisation would run upwards of Rs 3 lakh crore, maybe upwards of Rs 4 lakh crore, in terms of fresh Tier-1 capital.

Even if the government is willing to reduce equity stakes, it will find it hard to tap the markets for that sort of cash. If the government is unwilling to reduce equity stakes (more likely in an election year), it will scramble to find that cash from internal resources. So far, it has committed to subscribing about a fourth of the minimum amount that will be necessary.

Just putting up fresh capital will not be enough. The underlying issues must be dealt with. The NPAs built up over many years because of political interference and poor due-diligence. There is no incentive for PSBs to be run on commercially sane lines. In many banks, the government has not even bothered to appoint a chief executive officer (CEO). The market will not respond positively until these issues are addressed. RBI has set the ball rolling by forcing banks to present a true picture of losses. Now it's up to the owner to overhaul the banking system.