Infusion will not work, cut the banks loose

The government has decided to inject Rs 2.11 lakh crore into Public Sector Banks (PSBs), of which Rs 1.35 lakh crore will come from issuing recapitalisation bonds and Rs 76,000 crore through budgetary allocations and from the market. This is supposed to bail them out of the bad loan mess that is now a Rs 12 lakh crore mountain. But the bailout package is only a fraction of what is estimated to be necessary to restore state-owned banks to health. It is spread over five years, with uncertain budget allocations and dependency on bonds, on which they have to pay interest every year, not to mention the burdens they will impose beyond 2022. The plan does not take into account the higher reserve requirements banks will have to satisfy as the Basel III norms kick in by March 2019. Meanwhile, the process of partially recovering loans from defaulters under the Insolvency and Bankruptcy Code, which must necessarily complement the bailout, is failing.

The reason the PSBs need frequent bailouts is that they are always subject to political pressure. Most often, their "extend and pretend" behaviour is driven by the demands of those that are, in financial regulation, called “politically exposed persons”. Banks are also compelled to ignore their primary purpose because of government policy. In the past few years, they have been forced by the Union government onto the front lines of other policy battles. Now, far from cutting the apron strings, this big-ticket bailout will actually raise the Centre’s equity holdings in the PSBs, making them even more vulnerable to undue interference. The capital infusion the Centre is now willing to make might enable banks to tide over the immediate crisis, but it will do little to address the problems that they ail from. It also militates against the spirit of the original Indradhanush scheme that had tied infusions into PSBs to performance metrics.

This is not the first time the government is moving to bail out PSBs, and all the previous attempts failed. For public sector lenders to be truly back in the business of lending, it will take more than the infusion. Unless the PSBs are allowed to either run independently of government diktat, or are privatised, or are encouraged to slowly shrink into nothingness as private competitors expand, this recapitalisation is meaningless. Unfortunately, governance reforms at PSBs, particularly those related to the distancing of bank boards from government interference, have moved at a snail’s pace in the last three years. The best way to alleviate these concerns would be for the Centre to provide a roadmap for disinvestment from PSBs. Cut them loose.