Money-go-round is neat way to fix Indian banks

Haul to safety: The bonds allow the Centre to borrow from banks, and then use the funds as capital.

Haul to safety: The bonds allow the Centre to borrow from banks, and then use the funds as capital.  

Recapitalisation bonds may return

India is eyeing a circular solution to fix its banking mess. New Delhi might revive so-called “recapitalisation bonds”, which it used back in the 1990s. This makes sense given that banks are flush with deposits after Prime Minister Narendra Modi’s ban on big banknotes.

New Delhi will recapitalise its banks in the next few months, senior finance ministry official Sanjeev Sanyal said last week. He added that options included a mix of reducing the government’s stakes to 52%, a direct cash injection, and recapitalisation bonds.

Local banks need as much as $65 billion by 2019 to meet Basel III standards, Fitch Ratings reckons. With valuations below book value for most state banks, the government could raise barely $6 billion by reducing its stake in around 20 lenders. Nor does New Delhi have much cash to deploy in direct injections, since it is already stretched to meet a 3.2% fiscal-deficit target.

So, recapitalisation bonds could make a serious comeback.

Here the government borrows from the banks by issuing them bonds, and then uses the proceeds to bail the lenders out. This looks attractive because banks are flush with deposits, giving them firepower to lend, but credit demand is weak. Bank of Baroda grew deposits almost 5% over the year to end March but saw a decline in advances. Over time, New Delhi can potentially settle the debt by selling the bank equity it acquires using the bond proceeds.

Fiscal deficit impact

Neelkanth Mishra, equity strategist at Credit Suisse, says under some accounting standards this fix would not add to the fiscal deficit — though it would do under India’s current norms. Perhaps those might be changed.

Credit-rating agencies might not be impressed either, since this would add to the government’s overall debt burden, but the only obvious alternative, privatisation, is not on the table.

The details will matter. A 2003 IMF study of more than 40 bond issues for recapitalisation by countries including Algeria, Croatia, Indonesia, and Tanzania found such instruments are most effective when they are tradable and pay high enough coupons that banks can still fund loan growth. On the right terms, this money-go-round could get India’s key financial institutions moving again.

(The author is a Reuters Breakingviews columnist. Views are personal)

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Printable version | Feb 24, 2020 5:50:55 AM |

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