Financial engineering needed to ensure bank recap plan doesn’t dent economy

The Finance Ministry may have to do some tough financial engineering to ensure that the latest ₹2.11-lakh crore recapitalisation plan for public sector banks does not further strain the country’s economy at a time when there are concerns over growth slowdown.

The Ministry, which is expected to come out with a mechanism to implement this package that envisages recapitalisation bonds, will have to keep in mind the concerns being raised on impact on fiscal deficit – a situation where total expenditure exceeds the revenue.

Recapitalisation bonds count as debt after all and it is the government that is going to issue them.

Sanjeev Sanyal, Principal Economic Advisor to the Ministry of Finance, while pointing out that this is a legacy issue, told BusinessLine that “It can be argued that it is unfair to load it on to the fiscal deficit because it is a pre-existing problem which is being recognised and resolved now. Therefore, it should be ring-fenced in some fashion from the usual fiscal trajectory. I think it is a fair point.”

Unlike the International Monetary Fund accounting practices, where bank recapitalisation need not be part of the deficit, according to Indian accounting practices they are. “Now, it is a longer debate whether we change our accounting standard or not. So, for this particular issue, it may be easier to just ring-fence it.”

Sanyal gave two reasons for his suggestion: First, it will clarify for what the money is being used, and second, the value of government holdings in public sector banks. “Deficits do not always have a directly corresponding asset. But, here there is a liability side as well as an asset side. You are getting equity from the banks – there is a possibility of getting direct returns from it,” he points out.

Ask him on how will the recap bonds work, he explains, “Bonds will come from the government. Banks actually have lot of cash. The reason they are not lending is because they are not fully capitalised. If banks do not have underlying capital, they can’t lend as norms do not allow them to do so.”

With lots of cash, what do you do? “So, here is a peculiar situation where banks have lot of cash, but cannot lend, whereas RBI has liquidity management problems and ends up paying interest for this,” he elaborates, adding that “Now what government can do is borrow some of this cash using recap bonds, then put it back in the banks as capital. Then banks can leverage the capital and lend again.”

When asked whether this decision came a bit late, Sanyal says, “There was a reason for this. If the government did it too early, culture change in the banking system wouldn’t have happened and we would have merely funded yet another round of ever-greening. So the authorities had to hold their nerve a little in order to force realistic NPA resolutions and insolvency as well as force banks to write-down and make provisions. Only when there was some amount of pain on all parties, there will be a cultural change.”

Asked if he was hinting at the Insolvency and Bankruptcy Code, he says, “If recapitalisation had been done too early, then banks and debtors would not improve but go back to doing what they were doing before. Hence it was decided to use the IBC to force resolution and to empower RBI with an ordinance. Earlier, nobody was interested in resolving – neither the institutions nor debtors – because that was the culture of eternal ever-greening. IBC, NCLT and RBI’s enhanced powers caused a cultural break in the way of doing business and forced serious, proper economic resolutions.”

“Just read the papers to see how resolution is suddenly taken seriously,” he points out.

The Finance Minister, Arun Jaitley, when talking about this package had emphasised on lending to SMEs.

Asked if the Ministry was making some special dispensation for SMEs, he says, “SMEs are part of larger picture as SMEs are especially dependent on bank financing. Even if they were good SMEs and doing everything right, suddenly they found their working capital squeezed because the bank was not willing to give normal credit, or the corporate they were supplying was going into bankruptcy.”

“And unlike a big company which can go out and issue corporate bonds or borrow abroad, the SME is dependent on the banking system.

"There is recognition that this segment has faced part of the burden for this culture change, and so there is need for greater emphasis in this space.”