Strike at the root, and the branches will fall.
Maratha warrior Peshwa Bajirao followed the adage to remain undefeated throughout his life time. But the Indian banking system, caught in a fierce battle with non-performing assets (NPAs), does not have Peshwa’s luck despite help arriving from the Ministry of Finance and the Reserve Bank of India. The two entities have taken many steps to contain and reduce NPAs that accumulated as a result of inordinate delays in project execution, loss of raw material/supply linkage, high real interest rates and dumping by our trade partners.
Also, gold-plating of projects, faulty planning and poor execution etc were non-economic reasons for high levels of bad assets in the banking system.
A host of schemes, such as CDR, SDR, 5: 25 and S4A, had been launched in the past to reduce NPAs. Introduction of oversight committee along with the Insolvency and Bankruptcy Board of India is the latest step to ensure a time-bound settlement of NPAs.
Despite the efforts, banks have not found adequate capital to write off bad assets. Over the past three years, the government has provided Rs 60,000 crore towards recapitalisation, but that has not bridged the gap between what’s available and what banks require.
The government doesn’t have space under FRBM framework to recapitalise banks. The root cause of inadequate Capital to write off NPAs needs to be tackled along with other steps which are being taken. Clearly, these are tough times for banks, and desperate times, as they say, require desperate measures. The following steps can be considered to raise capital for the banking sector.
1. USE UNCLAIMED DEPOSITS
Many banks have unclaimed deposits (including balances in inoperative accounts). Many accounts will become inoperative with compulsory linking of Aadhar card. Such unclaimed deposits can be transferred to the government with a provision for future claims by the depositors. The same can be returned to banks as capital. It is extremely unlikely that depositors will go to the government to claim the deposits. The government has similar provision for unclaimed dividends.
2. MONETISE ASSETS OF CUSTODIAN OF ENEMY PROPERTY
The Custodian under Enemy Property Act of 1968 has Shares, Securities and Real Estate valued at more than Rs 100,000 crore, as per a PTI Report of March 17. The same can be monetised in a time bound and transparent manner to provide capital to the banking system. Those unproductive assets can be used more productively through such monetisation.
3. MONETISATION OF INVESTMENTS HELD BY BANKS
Banks have promoted many nation building institutions like rating agencies, exchanges and clearing corporations. They also have investments in financial services like insurance, broking, mutual fund, housing finance, factoring services etc. Many banks have started monetising such investments.
It can be explored more with markets lapping up all the recent issuances. Many banks with retail franchisee will create far more value through auctioning a bank assurance partnership than running an insurance company blocking precious capital.
4. USE OF FX RESERVE A LA CHINA
China had injected more than $60 billion of capital out of its foreign exchange reserves into its banking system in last decade. Since Chinese central bank-PBC couldn’t invest in commercial banks directly, a SPV called The Central Huijin Investment Corporation Limited (Huijin) was set up to receive funding from the PBC. India has 8th highest FX reserves in the world. Some amount can be borrowed from the FX reserves to recapitalize the banks.
5. REFINANCE FROM CENTRAL BANK BALANCE SHEET A LA US
US Fed spent $700 billion to purchase stressed assets like mortgage loans, student loans etc. from banks under TARP in 2008 during the subprime crisis. This was over and above guarantees and refinance of few trillion dollars. US Fed’s capital adequacy pales against that of RBI. Some of the stressed assets can be bought by the RBI directly or through SPV to release NPA pressure from the banking system.
6. TREASURY GAINS TO SET OFF NPAS
Indian Banks are holding Gilts worth Rs 29.5 trillion. 1% reduction in interest rates can create mark-to-market gains of Rs 1.18 trillion assuming portfolio duration of four years. Mark-to-market gains on treasury portfolios can be used to set off NPAs.
The current inflation trajectory is below RBI’s target rate. It is likely that RBI will succeed in containing inflationary expectations paving the way for lower interest rates. A fiscally prudent government an dan independent RBI should be able to achieve lower interest rates.
7. MAKE CRR REMUNERATIVE
Banks have to keep 4 % of deposits in CRR at zero return. This results into an opportunity loss of Rs 296 billion assuming that banks will be able to deploy the same at 7%. This is could be a transient step to help bank provide additional profitability. In the past three years, paying interest on CRR would have provided more capital to banks than government’s recapitalisation.
8. SALE AND LEASE-BACK OF ASSETS
The world is struggling for yield. There are more than $9 trillion worth of bonds at negative yields. FIIs preference of Indians credit and yield is visible in their investment over last few years. Banks have real estates at nominal book value in their book. (In the early 90s when I was doing my CA, I was taught that iconic SBI main branch building in Mumbai was having a book value of Rs 1/-) Banks should be encouraged (through tax exemption) to do sale and leaseback transactions to encash capital assets like real estate to unblock capital. The government can negotiate with sovereign funds, development agencies to provide low-cost financing for such sale and leaseback in lieu of exclusive entry in Indian markets.
9. STRUCTURAL IMPROVEMENT TO ATTRACT PRIVATE CAPITAL
Many of the private banks and foreign banks in India as well as abroad have employees who have their origin in PSU banking system. The market is unwilling to give capital to banks where there are concerns about the reported book value.
Market doesn’t like banks where decision making is influenced externally without accountability. Current compensation structure of PSU bank also creates doubt about attracting and retaining talents.
There is a need to make structural improvement in the banking system by making them truly board-governed with appropriate compensation structure. If the government’s ownership is brought below 51% in some of the banks to begin with, lot of private capital will be attracted. It is worth learning from India’s most successful military chief Peshwa Bajirao to strike at the root to tackle a problem.
Provision of capital to write down NPAs and structural reforms will make Indian banking system robust. It is a prerequisite to create double-digit economic growth for years to come.
(The author is managing director of Kotak Mutual Fund)
