After dragging its feet on the issue of recapitalisation of public sector banks, the Centre finally announced a recap plan of ₹2.1 lakh crore. Given that over the last five years, the Centre has infused about ₹89,000 crore (2012-2017) into PSBs, the bounty is sure to please the markets. But given that the capital the Centre has infused over the past several years has not aided growth and only helped banks fund losses on account of huge loan defaults, there is an urgent need to also kickstart structural reforms within the sector.

While the main aim of the Centre’s largesse is to boost lending activity, going by past data, capital infusion alone cannot ensure credit growth.

The overall loan growth for all PSBs put together was a meagre 2 per cent in 2015-16, even as the Centre infused around ₹20,000 crore during the year. The trend has been no different in 2016-17, with loan growth for PSBs still a meagre 1.9 per cent despite the Centre’s ₹23,000-odd crore of infusion. So, where have PSBs deployed these funds if not for growing their loan book? A key aspect of a bank’s capital is its ability to absorb losses in the normal course of operations. Digging into banks’ results reveals that the Centre’s funds have gone mostly to fund banks’ losses on account of huge loan defaults.

The core earnings of most PSBs have grossly fallen short of the requirement for bad loan provisioning (see table). For instance, IDBI Bank’s bad loans provisioning stood at ₹12,408 crore in 2016-17. But the bank only managed to deliver a core net interest income (interest earned on assets less interest paid on deposits and borrowings) of about ₹5,751 crore in 2016-17.

UCO Bank’s core net interest income stood at ₹3,816 crore, grossly short of the provisioning requirement of ₹4,414 crore for the fiscal. The bank’s operating profit of ₹2,926 crore for the year could hardly meet the provisioning requirement. The list goes on of banks delivering weak core earnings and passing the baton of absorbing losses to their capital. Hence, it is likely that the Centre’s capital infusion, even this time around, will continue to fund these banks’ losses rather than growth for some time.

As a fire-fighting measure, the Centre’s recap plan can help banks clean up their balance sheets and prep themselves for the next leg of lending. But this time it will be imperative for the Centre and the RBI to address the structural issues by reform of bank governance structures.

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