PSU banks may get ₹70,000 cr. via recap bonds in four months: 

PSU banks may get ₹70,000 cr. via recap bonds in four months: 

Context:

The Finance Ministry may infuse about Rs. 70,000 crore through recapitalisation bonds in the NPA-hit public sector banks (PSBs) in the next four months.

Introduction:

• Last month, Finance Minister Arun Jaitley had announced a Rs 2.11 lakh crore two-year roadmap for strengthening public sector banks.
• The plan included re-capitalisation bonds of Rs 1.35 lakh crore.
• Presently, the government is finalizing the structure of bonds and decision in this regard could be made very soon.
• The latest figures shown in the ministry presentation put the increase in non-performing assets (NPAs) from financial year (FY) 2015 till June 2017 at Rs4.55 trillion.

Rationale behind decision by the government:

• By infusing capital, the government is trying to partially improve the balance sheets of public sector banks.
• This will also help banks write off some of the Rs 10 lakh crore bad loans currently on their books.
• For tackling the problem of stressed assets.
• The amount is expected to help put India’s banks on the path to recovery.

Means through which Recapitalization can be done:

• The governments have recapitalized banks through various means. These can be mainly divided into direct capital infusion, issuance of public debt into banks either as a swap for bad assets or unrequited, and by assuming the bank’s liabilities.

Growing NPAs of public sector banks:

• Non-performing assets (NPAs) of public sector banks alone have increased from Rs. 2.75 lakh crore as on March 2015 to Rs. 7.33 lakh crore as on June 2017.
• Besides the bonds, the Minister announced banks would get about Rs. 18,000 crore under Indradhanush plan over the next two years.

What is Recapitalisation bonds?

• Recapitalisation bonds are dedicated bonds to be issued at the behest of the government for recapitalizing the trouble hit Public Sector Banks (PSBs).
• Recapitalization bonds are proposed as a part of the Rs 2.11 trillion capital infusion package declared by the government recently.
• The term recapitalisation means giving equity money to cover debt of an entity.
• In the case of PSBs, their NPAs (debts) will be replaced by equity capital from recapitalisation by the government.
• Money obtained from the sale of the bonds will be injected into the PSBs as government equity funding.
• Procedures for the issue of the bonds and the working mechanisms are yet to be decided by the government.

How the Recapitalisation Bond issue will work?

• The bond, once issued by the holding company, will be subscribed by public sector banks themselves.
• Fund from the issue of bonds will be used to subscribe shares of PSBs and will be treated as additional government equity or capital.
• The capital of PSBs will be enhanced thereby helping them to tackle the present NPA problems.
• Banks at present have adequate funds as the credit growth was low in the past few years. Banks have funds from the demonetization period deposits. At least 1 trillion rupees is supposed to be with the banking system where the depositors have to give explanation for the source of income.

How recapitalization will help banks to tackle the NPA problem?

• The Public Sector Banks will get additional capital from the government from the issue of the bonds. The amount of capital to be obtained by each PSB will be determined later and it depends upon the depth of their NPA problem.
• Banks once obtained the funds, can write-off the bad assets by using the fund from recapitalization.
• As per the Basel III norms, there should be a minimum higher quality capital like equity capital.

What are Non Performing Assets (NPAs)?

• A non performing asset (NPA) is a loan or advance for which the principal or interest payment remained overdue for a period of 90 days.
• Banks are required to classify NPAs further into Substandard, Doubtful and Loss assets.
• Substandard assets: Assets which has remained NPA for a period less than or equal to 12 months.
• Doubtful assets: An asset would be classified as doubtful if it has remained in the substandard category for a period of 12 months.
• Loss assets: As per RBI, Loss asset is considered uncollectible and of such little value that its continuance as a bankable asset is not warranted, although there may be some salvage or recovery value.

What are the reasons for the rise of NPAs?

• The banking sector has been facing the severe problems of the rising NPAs. Following are the major reasons:

External Factors:

• Ineffective recovery tribunal: The government has set an array of recovery tribunals, which works for recovery of loans and advances, due to their carelessness and ineffectiveness in their work the bank suffers the consequence of non-recover, their by reducing their profitability and liquidity.
• Natural calamities: Every now and then India is hit by major natural calamities thus making the borrowers unable to payback their loans.
• Thus the bank has to make large amount of provisions in order to pay damages those loans, hence end up the fiscal with a reduced profit.
• Industrial sickness: Inappropriate project handling , ineffective management , lack of adequate resources , lack of advance technology , day to day changing government policies produce industrial sickness.
• Therefore the banks that finance those industries ultimately end up with a low recovery of their loans reducing their profit and liquidity.

Internal Factors:

• Inappropriate technology: Proper Management Information System (MIS) and financial accounting system is not implemented in the banks, which leads to poor credit collection.
• Improper analysis: The inappropriate strength, weakness, opportunity and threat analysis is another reason for increase in NPAs.
• Poor Credit Appraisal: Deprived credit appraisal is an additional factor for the increase in NPAs, due to poor credit appraisal the bank gives advances to those who are not able to repay it back.

What steps has the government taken?

• Mission Indradhanush: Government has launched ‘Mission Indradhanush’ to make the working of public sector bank more transparent and professional in order to curb the menace of NPA in future.
• Insolvency and Bankruptcy Code, 2016 (IBC): It is the bankruptcy law of India which seeks to consolidate the existing framework by creating a single law for insolvency and bankruptcy.
• Reserve Bank of India: RBI introduced number of measures in last few years  which include: tightening the Corporate Debt Restructuring (CDR) mechanism, setting up a Joint Lenders’ Forum, prodding banks to disclose the real picture of bad loans, asking them to increase provisioning for stressed assets, introducing a 5:25 scheme where loans are to be amortized over 25 years with refinancing option after every 5  years, and empowering them to take majority control in defaulting companies under the Strategic Debt Restructuring (SDR) scheme.

What is Bank recapitalization?

• Bank recapitalization means recapitalising banks with new capital to improve their balance sheet.
• The government, using different instruments to add capital into banks which undergoing credit deficiency.
• Since the government is the biggest shareholder in public sector banks, the responsibility of infusing capital majorly lies with the government.

How Bank recapitalization takes place?

• The recapitalisation plan comes into action when banks get caught in a situation where their liabilities are comparatively higher than their assets.
• The liquidity with banks is a liability as it is the money deposited by customers, which needs to be paid sooner or later.
• Due to this their balance-sheet weakens and banks find it difficult to raise capital from the open market.
• Thus, the government, which is also the biggest shareholder, can infuse capital in banks by either buying new shares or by issuing bonds.

Why has Recapitalisation of the Banks Occurred?

• Recapitalisation of the Banks occurs when:
• People defaulted on loans and mortgages;
• banks lent money (bought CDOs) to sub-prime mortgage companies in America who lost money;
• falling house prices means that banks assets decline further and if they repossess homes it’s harder to get value of the original loan back, and
• recession led to more defaults and losses.

Public sector versus private sector banks:

• Mismanagement:  private banks owners, who have invested their own money and stand to lose it all in case of mismanagement, have a strong economic incentive.
• It is a good effort compared to the almost complete negligence and gross mismanagement of books in the case of public sector banks.
• Bad loans: private banks rarely face the problems of bad loans, which is a part and parcel of lending aggressively under a fractional reserve banking system.
• But in the case of public sector banks, the implicit guarantee of their books by the government only adds to it the risk of moral hazard.
• Taxpayer money: as nationalised banks are allowed to tap into taxpayer money whenever they are in deep financial trouble, they have very little reason to be careful while lending and more reason to take huge risks with their balance sheets.
• Incidentally, the same happens whenever the government protects private sector banks from the negative consequences of their actions.