The festering issue of weak PSBs

Setting an unsettling precedence for investors and banks, the RBI recently moved to write down Tier 2 bonds of troubled Lakshmi Vilas Bank before its merger with DBS Bank India. Coming on the heels of the YES Bank episode – when the central bank wrote down ₹8,400 crore of the bank’s additional Tier 1 bonds (AT 1 bonds) – raising capital via bank bonds could get challenging and dearer for some private banks.

Interestingly, though, investors now seem to prefer bank bonds issued by public sector banks (despite their weak finances). With the Centre continuing to pump capital into troubled PSBs, investors seem to draw an eerie comfort from an unlikely ‘YES Bank or LVB’ fiasco at PSBs.

But herein lies the chink.

The Centre’s weak finances has now limited its ability to continue its largess year after year. How long can the Centre meet the needs of perennially capital-starved PSBs? Can these banks not fend for themselves?

How deep is the malaise?

The sharp jump in the quantum of capital infusion in recent yearsis extremely worrisome. Sample this, between FY11 and FY17, the government infused close to ₹1.2-lakh crore into PSBs, while in the past three fiscals alone (between FY18 and FY20), recapitalisation has been a mind-boggling ₹2.6-lakh crore.

Much of the capital infused by the Centre in recent years has gone to absorb losses due to the sharp rise in bad loans. From 4 per cent levels in FY14, gross NPAs shot up to 12-13 per cent by FY20 for PSBs. The bad loan menace is much deeper in some banks.

Consider PNB. The Centre has pumped in nearly ₹38,000 crore into the bank over the past four fiscals. Yet after the botched up merger with weaker banks this fiscal – Oriental Bank of Commerce and United Bank – PNB (now the second largest PSB by asset size) would continue to require huge sums of capital.

Even as the Centre has infused ₹20,000 crore into Union Bank during FY18-FY20, the ordeal for the bank is far from over with Andhra and Corporation Bank merging into it.

Aside from these mammoth institutions (created by the Centre’s shotgun weddings) continuing to guzzle capital, we have other sizeable banks (left out of the merger exercise) such as Bank of India, Central Bank of India, Indian Overseas Bankand UCO Bank that have also seen massive capital infusion in recent years.

What is additionally worrisome is that these PSBs have turned to ‘lazy banking’. Numbers suggest a steady decline in risk-weighted assets for most PSBs over the past few years – moving to safer and less risky loans assets. Unless we have strong banks taking calculated risks on corporate lending, a sustainable economic growth is unlikely.

Unlocking value in subsidiaries

So, can PSBs fend for themselves? One way in which some PSBs can raise capital is by unlocking value in their non-core businesses. Our findings show that many banks have notable investments in insurance businesses, asset management companies and housing finance companies that can be monetised.

SBI is a case in point. In FY18, SBI raised ₹5,400 crore via partial stake sale in SBI Life. In FY19, it raised ₹473 crore on sale of part investment in SBI General. In FY20, it raked in ₹3,484 crore via partial stake sale in SBI Life and ₹2,731 crore through SBI Cards and Payments IPO. There is still huge potential for SBI to raise capital through stake sale in other subsidiaries, such as SBI Funds.

The Centre has not infused any capital into SBI in the past two fiscals.

There are other PSBs that also have notable investments. Canara Bank has holdings in Canara Robeco AMC, Can Fin Homes, and Canara HSBC OBC Life. PNB has investments in PNB Gilts (listed primary dealer of debt securities), PNB Housing Finance and PNB Metlife India Insurance. Partial stake sale in some of these could fetch the bank a few thousand crores.

While these stake sales can help to some extent, how can the massive capital needs of these banks – and others that don’t have sizeable investments to monetise – be met?

Kindling investor interest

The previous Budget had struck all the right notes, promising governance reforms, transparency and greater professionalism. But as in the past, these reforms remain on the shelf. The Centre had also nudged PSBs to raise money from the market.

Easier said! PSBs have been trading at less than their book value (0.4-0.6 times book). Yet they have found few takers.

To kindle investor interest, it is imperative for the Centre to implement long-pending recommendations of creating holding company structure and empowering bank boards, to ensure that the government maintains arm’s length from the management of PSBs. The next step would be dilute government’s stake below 50 per cent (only after a strong governance structure is in place). These reforms have to be undertaken in a time-bound manner, otherwise the festering issue of under-capitalised PSBs could cost the economy dearly.