Last week saw bank shares take a hammering, as investors focused on the rise of non-performing assets (NPAs) across the system. According to some estimates, 12 per cent of bank assets are stressed and the official numbers might be understated. Stressed assets include both NPAs, where debts are not being serviced, and restructured assets, where the terms of debt servicing have been renegotiated. A lot of restructured assets will eventually become NPAs.
About 90 per cent of stressed assets are held by public sector banks (PSBs), 70-75 per cent of all banks' credit. Stressed assets continued to rise through the current financial year. In effect, this means net worth of many PSBs could be wiped out if all those loans go sour. This situation would be bad enough under normal circumstances. PSBs would need to be recapitalised to compensate for the huge, inevitable write-offs. But there are several reasons why the stresses on the banking system are even worse than under normal circumstances.
Banks now have to meet stiffer net worth considerations under the global Basel III norms. This means the owner-promoters must subscribe to more equity (and/or more preferential debt). At the very least, the government will have to come up with Rs 2,40,000 crore in terms of such commitments to shore up its equity holdings in PSBs. It is very likely the government will have to contribute far more.
The alternative - sell stakes and dilute government equity holdings - is politically unacceptable. It would also be a bad bargain for the government at the moment, as many PSBs are trading below book value precisely because of the stressed assets on their balance sheets. The government has plenty of other calls on its financial resources. But, political considerations have in general, over-ridden fiscal prudence, when it comes to the government's management of the banks it controls. There have been multiple restructurings of bad loans, as well as forgiveness of loans that should never have been sanctioned. Successive governments have tended to kick these problems under the table, rather than tackle head-on. There have been two large bailout packages for state electricity distribution companies, which are serial offenders in terms of not paying up.
In contrast, private sector banks have a much lower percentage of stressed assets on their books. Also, by and large, these banks have been successful in reducing exposures to stressed assets. This difference is recognised by the market. Private banks trade at valuations that are multiples higher than those of PSBs. Problems of this magnitude often tend to infect the entire financial ecosystem, and even private banks could face problems. If bailouts are required, panic could hit all banks indiscriminately. Plus, PSBs are currently reluctant to lower interest rates and also reluctant to increase exposures. Hence, private banks are also keeping their interest rates up.
The government must find the money to recapitalise. It has committed around Rs 70,000 crore to this process. But that is less than a third of the minimum necessary amount. If full recapitalisation is to happen without equity dilution, all the savings accruing from lower energy prices, plus some more cash, will have to be pumped into banks.
One alternative would be to find ways to accelerate growth. If growth improves, companies would find it easier to service debts. However, this runs into Catch-22. Growth acceleration usually involves investment and banks cannot support much investment at the moment.
On the positive side, things are not getting worse. Economic growth should improve from here on. Moody's recently upgraded Indian banking to 'stable' from 'negative' because it sees an improvement in the operating environment. The credit rating agency says NPAs could increase from here but the pace at which NPAs are created will get slower.
All this is contingent on crude oil prices staying low for long enough for economic growth to accelerate and for the banking sector to recover. There is also the assumption that the government will finally allow the banks it controls to be run on commercially prudent lines. That would mean reversing decades of politicians treating PSBs like personal fiefdoms and piggybanks.
The banking system is inching closer to a financial crisis. If that crisis is averted and there is a genuine recovery, PSBs could see their valuations double or triple. On the other hand, mishandling of the situation could lead to a downward spiral for the entire sector.
