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Unexpected dilemma for banks, Govt.

The Exchequer has an unexpected opportunity to get back a part of its bank equity at a premium. However, the issues are not as clear-cut as the supporters and opponents of the idea would like to think, says C. R. L. Narasimhan.

THE SUSTAINED interest in bank stocks, especially public sector bank shares, had reached frenzied levels last week. The Union Finance Ministry added to the confusion and probably stoked the already strong speculative tendencies by taking contradictory positions on what has become a controversial issue: the return of government owned capital invested in the PSBs. Should the banks buy back a portion of their equity capital held by the Government at a premium? Aspects of this controversy will linger long after the Government decides on a formula that will do justice to both the PSBs and their other stakeholders.

Two related aspects however need to be looked into. First, the probable reasons as to why a sector, so long eclipsed in the market, has suddenly come into the limelight.

Second, does the increase in their market capitalisation confer any tangible benefit to their predominant owners, the Government?

The first issue also prompts the question: is the current market fascination for PSB stocks no more than a blip, to vanish when the speculative bubble bursts? The Government's often varying postures have lent a sharp edge to the more general question of whether or how the owners of these banks can share in the largesse from the stock market boom.

This is not merely a question of the Government-owner getting back the money it had sunk in the majority of PSBs but also involves a relook at the traditional ways open to the majority shareholder in any entity to recompense itself.

Specifically, when as part of a well-thought out financial sector restructuring programme the Government recapitalised a majority of capital-impaired PSBs in the Nineties, did it have a clue that in an unexpectedly short time it will reap capital gains?

These and other like issues would have remained theoretical had not the banking sector (in which the Government ownership is still dominant) caught the fancy of the Indian stock market.

Hot market favourites

That had seemed highly improbable even a year ago. Whoever visualised public sector bank stocks becoming the favourites of the stock market? Traditionally valued at abysmally low levels, they have been "discovered'' and the prices of most of them started zooming along with trading volumes. At one stage stock analysts were suggesting that PSB shares had become the investors' choice, preferred even over the IT shares that had fallen out of favour. A few individual shareholders who had subscribed to the initial public offerings of these banks were probably focussed on securing a steady return in the form of dividends. Suddenly a chance has come their way to book capital gains.

Much the same logic seems to be behind the argument that the Government should get a market-linked premium along with the portion of returned share capital from the PSBs. Unlike individuals, however, the Government-owner does not have a clear-cut choice.

There are many reasons for this sudden shift in investor preference and the consequent interest in PSB stocks. Some of these are straightforward. Others are more complicated, but together they support the view that economic reform in India in one of its key facets has been a success.

Today, if the Government and the PSBs face some kind of dilemma over the latter returning to the former a portion of their capital, it arises out of a completely unanticipated development — the upsurge in the market price of PSB shares.

The Government has not only been the owner but at a critical juncture in the history of the PSBs supported their capital structure with badly needed funds. It pumped fresh funds for as much as Rs. 22,516 crores, which have gone into their Tier I capital. In return the banks had to invest these in recapitalisation bonds, specially issued by the Government.

In effect there has been only a book entry but the Government does have a direct financial implication in this arrangement. It has to pay interest on these bonds. Far more significant however is the idea behind the recapitalisation itself without which some of the aided PSBs might well have gone out of business.

Focus on profitability

The obvious reasons behind the current interest in PSB shares can be listed: their owners, the majority stakeholder (the Government) as well as the newer public shareholders have made the banks refocus on core profitability issues. That of course has been one of the critical items of the reform agenda. More specifically, PSBs as a class are reaping the benefits of a falling interest rate environment. In recent years they booked huge treasury profits by selling off a portion of their high yielding investments in gilts.

Having belatedly joined the technology bandwagon, many PSBs have no choice but to invest further and strive towards catching up with both the new private banks and the foreign banks. That has already changed their perception and should in course of time boost their profitability.

Again through VRS almost all the banks have pared down their fixed costs. Also, there is greater awareness of problem loans and more relevantly the banks have been given a measure of legal ammunition to tackle them.

One can add a few other factors that might have fuelled interest in bank shares. But do they explain the degree of interest seen? Compared to a year ago all PSB stocks have moved up.

For instance, Andhra Bank has moved up from Rs.10 to around Rs. 33, IOB from Rs. 9 to Rs. 25, Oriental Bank of Commerce from Rs. 42 to Rs.135, SBBJ from Rs. 376 to Rs. 676. Canara Bank, which has reported abnormal profits last year made its IPO in May last year at an issue price of Rs. 35. Today, along with that of PNB (also a late entrant on the IPO scene) it is leading the charge of PSB shares. In both cases neither their recent financial performance nor the more general factors favouring bank stocks can fully explain the market's sudden fancy for them.

After all government ownership is always viewed in a negative way by the stock markets. This is true across all sectors. Despite the announcement of the decision to reduce the government stake in PSBs to a third, there has hardly been any concrete follow up action.

Even the PSBs financials, shorn of the glittering treasury income, are widely expected to be more modest in the coming years. It is reasonable to assume that the general level of interest rates will not move down further. Simultaneously the spread income (arising out of the difference between interest paid and received) is bound to shrink. As for technology enhancing productivity and therefore profitability, for PSBS it might be an elusive goal at least over the next few years.

Lack of clear-cut guidance

Whether the interest in PSB stocks is sustained or not, the question of the Government getting its due has to be addressed almost immediately. If the PSBs do retire some of the Government's equity, what price should they pay?

The market price or the book value plus interest earned on recapitalisation bonds minus dividends paid to the Government? The former will favour the Government at the present juncture as it well resembles the more conventional equity buy-back by firms.

The latter is akin to a debt repayment, the money given to the banks now being returned.

There are arguments in support of both views but because of the Finance Ministry's lack of clear-cut guidance, the underlying issues have become more complicated than they should be. Also, the present debate has sidestepped other basic points.

For instance, are the PSBs being hasty in offering to return the capital, even if they are eligible to do so? Inextricably, the overall reform issues will have to squarely face: what should be the Government's role in the financial sector?

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