Public sector banks (PSBs) must swiftly be recapitalised, given looming bad loans and write-offs. The choice is between capital infusion by the majority owner, the State, and raising capital, equity and debt, from the public. The banks and their owner, the State, should opt for public issues to shore up bank capital. Capital is available in plenty from the far corners of the world, and cheap. The real question is, can supervision and regulation improve to a level that inspires sufficient investor confidence to draw in the capital required? We urge the government to have a serious go at such improvement, and the result would, in tandem with the creation of a vibrant market for corporate bonds that relieves banks of the risk of funding long-gestation projects they are ill-suited to finance, create well-capitalised banks that are answerable to savvy shareholders on the board.
Serious write-offs for banks are inevitable, whether a bad bank is created to buy assets off the PSBs or the bankruptcy code is put to use for the resolution of bad loans. The writing off of a bad loan means that the bank would have to make 100% provisioning (setting aside capital) against the loan to protect depositors even if that loan is not repaid, and clean-up its books. Banks wrote off a whopping Rs 2,37,876 crore in 2019-20 that enabled them to show lower NPAs, but RBI has warned that the modest NPA ratio of 7.5% at end-September 2020 ‘veils the strong undercurrent of slippage’. It makes eminent sense for banks to raise equity capital from the public, rather than from the government that burdens the taxpayer while recapitalising banks. After all, broad-based shareholding is feasible as banking is seen as a safe business: banks have a guaranteed clientele besides a growing depositor base, and face limited competition.
Raising equity from the public will, besides giving the government fiscal room, help lower State ownership below 51%, giving PSBs leeway to step outside the shadow of vigilance supervision and to fix their own remuneration plans.