The Reserve bank had asked the PSBs to come upfront with their bad debts. Thus banks had to recognise the bad debts and declare them in their balance sheets. The recognition of bad debts immediately had an impact on their profitability and they announced big dents in profits. This, in turn, affected their share prices in the markets.

The knock down of banks profitability and erosion of their share capital because of setting of losses from bad debts meant need for fresh capital infusion into public sector banks. The finance minister’s provision of Rs 25,000 crore for recapitalisation of banks could at most be considered the first step.

Banks need some Rs 1,80,000 crore fresh capital for take care of the overall incidence of bad debts. So provision of Rs 25,000 crore is measly. However, the finance minister announced that the government stands solidly behind the banks. The finance minister’s strong statement is reassuring. Following the budget, some of the bank shares have gone up.

However, the total burden of NPAs, along with accounts which are being restructured through say CDR, would amount to over Rs7 lakh crore. Public sector banks own about 85% of the total bad debts and this weighs on their operations. One major implication is that these bad debt ridden banks are unable to extend loans and loans drying up means serious impediments for industry and business.

This needs to be tackled. But the problem is so large and deep it cannot be cured within the framework of a couple of years. This would have to be addressed spread over years. One single budget therefore is of not much consequence, apart from starting to work on the banks’ rehabilitation. This is all that the finance minister could be said to have done in this budget.

The issue of banks’ NPA has been somewhat made further complicated by the reference in this year’s Economic Survey of the so-called “Twin Balance Sheet Problems”. This is a smart formulation at best. The Survey pointed out that the bad debts on banks’ balance sheet is acting as a check on fresh lending and investment. On the other hand, the outstanding debts of the corporates is pinching on their capacity to invest.

So, the current lack of investment in the economy is originating from the bad balance sheets of the banks, on the one, and the impaired balance sheets of the affected corporates on the other.

This is neither true nor is realistic. Private sector investment is not happening not because of the impaired balance sheets of some ten to twelve large corporates in infrastructure, steel, textiles and some cited sectors. This is not forthcoming because overall demand is low. The Survey has in fact pointed out that capacity utilisation of domestic industry is just around 70%. At 70% capacity utilisation no company will ever think of fresh investment to create fresh capacity.

And then, if some sectors have disproportionately high outstanding loans which they are not in a position to repay in time, there are other companies which have solid balance sheets and large free reserves. But even in their case, investments are not forthcoming.

If there is a balance sheet problem it is one of the PSBs which is calling for some remedial actions. The remedy is not always some financial manipulation or restructuring. The remedy lies also in procedural changes. The moment the procedure for settling banks claims against companies which have failed to honour debt repayment schedule is set right and facilitated, the greater part of the outstanding could be resolved.

These companies in the infrastructure sectors have large real assets which can be acquired by banks and sold off against loans. The problem lies in procedure for such take over. This calls for robust government moves in this respect. The finance minister has not made any announcement to this effect in his budget or the government has not resolved to set right this issue.

Secondly, the banks’ NPA crisis could also be resolved by once again inserting the former convertibility clause in loan agreements. The convertibility clause empowers a bank, by agreement, to convert its dues into equity capital of the concerned companies. This used to be invariable feature of banks loan agreements. However, the use of this clause was dropped on persistent opposition from Indian industry. It is time that the clause is re-introduced effectively for all loan agreements between banks and corporate borrowers.

Having the convertibility clause will mean that banks would be in a position to take over management of companies the moment the loans turn bad. The threat of a takeover will make the borrowers behave and at least willful defaulters will be intimidated. Besides, having convertibility clause, the strengthened monitoring by banks could mount enough vigilance to deter will default.

Thirdly, instead of the government providing small capital infusion in driblets, the government should ask the banks themselves to raise capital from the market. The argument going this proposal is that the market valuation of bank shares is such that banks will not get a good price for their equity offers. However, if the banks are required to raise capital instead of getting it on a platter, they should also behave more responsibly and be always on their toes to keep things like bad debts at the minimum level. This is not happening now. Arun Jaitley could have taken such an approach and imposed more responsibility on bank managements as well which he did not.

However, his assertion that the government is behind the PSBs “solidly” is enough to give some confidence to investors. Some time not too distant a future, banks should be able to raise capital on their own and help themselves get rehabilitated. Why doesn’t government take that route? (IPA Service)