Prof. T. T. Ram Mohan , a professor of finance and accounting at the Indian Institute of Management, Ahmedabad, has welcomed the government’s initiative to infuse funds into banks through the use of recapitalisation bonds. Opining that the NDA administration was remiss in not opting for recapitalisation as soon as it came to power, he has earlier written that infusing funds into banks was not tantamount to money ‘going down the drain’ but that it allowed for banks to use capital for lending, which would improve their profitability. The higher return on equity should more than compensate for the government’s interest cost, he said. Excerpts from an email interview:
Should the government opt for perpetual bonds or should there be a tenure?
Perpetual bonds would saddle the government with a permanent debt obligation. A fixed tenure bond would impose a certain fiscal discipline on the government. Moreover, we do expect the growth outlook will improve in the coming years and hence repayment should not pose a problem. As to tenure, a 10-year bond should be okay.
What lessons should be taken from the recap exercise undertaken in 1993-95?
The amount involved then was much smaller. Following the recap, PSBs started improving their performance. Partly, this was because of improved growth but also it was because of a better focus on commercial performance all around. The government can take an optimistic view based on the earlier experience. Wherever large banks fail, governments tend to recapitalise as quickly as possible to avoid disruption to the economy.
The Government of India should, of course, seek to improve governance and management at PSBs so as to minimise the probability of recurrence of large NPAs or losses.
Why haven’t governments used it more often? How does it work elsewhere?
Well, it involves use of tax payer money, so you have to be careful. Governments the world over have used recapitalisation to cope with banking failures and crises — an IMF study has documented 140 episodes of banking crises in 115 economies in the period 1970-2011, which involved substantial use of tax payer money for recapitalisation of banks.
You have said that factors such as the 2008 crisis contributed to bank NPAs rising. What steps are needed to prevent high NPAs, low capital adequacy and banks returning with a begging bowl?
Not just the 2008 financial crisis and the resultant global slowdown but events such as the glut in steel created by China and adverse court judgements in 2G, coal block allocation, iron ore mining etc. have contributed to the problem.
The fact that it’s not just a PSB problem is borne out by the high NPA level at ICICI Bank.
Gross NPA at ICICI Bank is 8% — not very different from SBI’s 10%. ICICI Bank has all the talent and credit risk appraisal skills you can think of, management has incentives and the bank has an independent board !
It’s hard to argue, therefore, that public ownership is the crucial factor in the high level of NPAs at public sector banks.
We do need better risk management at banks in general, including limiting exposures to long-term finance such as infrastructure. We also need to be more rigorous in selecting CEOs at PSBs and focus on the nuts and bolts of HR such as succession planning.
But aren’t infrastructure projects predominantly dependent on bank funding?
Being of long duration, these are best financed by the bond market. Banks are not well-suited for such financing as it tends to create a mismatch between their short-term liabilities and long-term assets. It is not that banks should avoid such funding but it should be subject to prudential limits.
Is ₹9,000 crore in annual interest, which is bandied about, all that the government would be faced with?
Yes
Opinions differ on whether there would be an impact on fiscal deficit.
Any government borrowing means an impact on the fiscal deficit. It’s a different matter that the IMF allows an accounting fudge in this respect and doesn’t count borrowing for bank capital as fiscal deficit.
Is there an estimate of how much more fiscal deficit would expand, from the targeted 3.2%?
That depends on whether the amount is infused at one go or in more than one budget. If done at one go, it would add approximately one percentage point to the fiscal deficit.
What benefits, versus the cost of a larger fiscal deficit, do you see in this recapitalisation exercise?
We need to get credit flows going so that private production and investment pick up. The need for a fiscal stimulus is recognised by many but economists don’t think that government consumption spending or public investment is the best answer. I would argue that bank recap is the right stimulus at the present time.
If banks invest in government bonds that convert idle deposits into equity, isn’t it dangerous to convert depositors’ money into equity for the government?
Banks are investing in government recapitalisation bonds. So, depositors’ funds are going into safe government bonds instead of going into risky loans. When the government uses the proceeds to invest in banks’ equity, on the liabilities side of the balance sheet, deposits or borrowings decrease and equity increases. This means leverage is going down and capital adequacy is increasing. Thus, PSBs become safer as a result of the capital infusion. This is one reason PSB stocks have risen after the announcement of recapitalisation, the other being the fact that they can grow loans faster than before on the strength of higher capital.
What else must the government be committed to?
We could certainly use better boards and the finance ministry must express its views through its board representatives instead of giving instructions “offline”. This would strengthen the functioning of PSB boards.
The government must bring quality professionals on to the boards of Public Sector Banks — this would require government to improve compensation for independent directors.
However, talk of political interference coming in the way of PSB performance is overblown.
Most PSB CEOs will tell you that in recent years, they have faced little interference on the whole.
RBI must provide a guiding hand when it comes to risk management. Their draft for Large Exposure Framework is a good one and should be pursued.
Has the Banks Board Bureau lived up to expectations?
The BBB, in my view, is an ill-conceived creation. It is unrealistic to expect the government as the majority owner of PSBs to be distanced from key appointments to PSBs. The creation of the BBB has just added one more layer to the appointment process. The BBB has understandably failed to live up to its ambitious mandate. It should be wound up.
