Forget lessons from the past, Arun Jaitley’s bank recapitalisation even buried a July audit report

Hailed as a “big-bang move” by bankers, the government’s plan to recapitalise public sector banks with Rs 2.1 lakh crores is deemed to hold magical powers that will help turn around their financial situations. The announcement of the plan by Finance Minister Arun Jaitley on October 24 was a reiteration of what he had said in July 2014, just a few months after the Bharatiya Janata Party had come to power. He had said then that a capital infusion of Rs 2.4 lakh crores into state-run banks to help them meet Basel III norms was a top priority of the government. (The Basel III standards set a minimum capital cushion a bank must keep to absorb losses on loans).

So, what happened in the three years pursuant to that announcement in 2014?

Gross non-performing assets (or loans unpaid for more than nine months plus the “provisioned money” set aside by banks in case the loans turn bad) jumped from 4.4% in 2014 to 10.2% in 2017. Submitting the names of big loan defaulters to the Supreme Court in July, the Reserve Bank of India refused to make the names public, arguing that such a move would hurt their businesses. Vijay Mallya, a poster boy for bad loans who owes banks more than Rs 9,000 crores loaned to his now defunct Kingfisher Airlines, had fled the country in March the previous year.

A month before submitting the list in the Supreme Court, the Reserve Bank sent banks a list of 12 defaulters, responsible for 25% of the bad loans in the banking system, with directions to initiate bankruptcy proceedings against them in the National Company Law Tribunal. The recovery from the first case filed in the tribunal under the Insolvency and Bankruptcy Code, that of Synergies-Dooray Automotive, was only 6%.

Importantly, no major policy decisions were taken in those three years to plug the leaks from public sector banks. Nor was there any demonstration of political will to recover bad loans from big defaulters. The 10 top defaulters are Reliance, Vedanta, Essar, Adani, Jaypee, JSW, GMR, Lanco, Videocon and GVK.

As three years were wasted, leakages continued to weaken the banking system, exposing it to high vulnerability. The promised capital infusion of Rs 2.1 lakh crores over the next two years is, therefore, a case of fixing the roof when the foundation is fast eroding.

According to the plan, Rs 1.3 lakh crores will be raised through recapitalisation bonds, the government will make a budgetary allocation of Rs 18,000 crores, and Rs 58,000 crores will come from the sale of shares. Recapitalisation bonds are instruments issued by the government that banks can buy. The government will, in turn, use the money raised through their sale to provide more capital to banks.

Auditor’s warning

This is not the first time the present government has infused capital into public sector banks. In 2015, it injected Rs 70,000 crores, allocating from the budget, under the Indradhanush Plan. But that did not help the banks straighten their debt-laden backs and the government has now decided to put in three times more. While doing so, it does not seem to have investigated why the previous capital infusion did not work.

Also, last week’s announcement has summarily buried the findings of a report by the Comptroller and Auditor General on the recapitalisation of public sector banks released in July. The auditor had looked at the period between 2008-2009 and 2016-2017 during which public sector banks received Rs 1.1 lakh crores from the government. The report said the State Bank of India received the biggest share of the recapitalisation at Rs 26,948 crores, or 22.7% of the total. The Central Bank of India, IDBI Bank, Indian Overseas Bank and Bank of India were the other significant beneficiaries, each receiving a little under 9% of the total amount.

According to the CARE Ratings, the bank-wise ratio of net non-performing assets to loans as of June 2017 stood at: State Bank of India 9.9%, IDBI Bank 24.1%, Central Bank of India 18.2%, Indian Overseas Bank 23.6% and Bank of India 13%.

Quoting responses from the Department of Financial Services under the Ministry of Finance, the Comptroller and Auditor General said that in 2015, the department shifted from need-based capital infusion to performance/profitability-based capital infusion. It pointed out that this shift had to be seen in the backdrop of the department’s observation in October 2014 that the achievements of all banks “had been below par and had directed all PSBs [public sector banks] to strengthen their internal processes and generate additional capital savings in the near-to-medium term”. However, the auditor noted that in 2016, “as most of the banks fell short of the targets set, performance was not considered as the basis for capital infusion during the year”.

Indicating the inability of the Department of Financial Services to guide state-run banks out of the mess, the report said that in March 2016, the department decided that 25% of the capital would be infused into the banks upfront and the remaining 75% on the basis of their performance. “It was specifically stated that banks which do not achieve the targets would not receive further funds,” the report said. However, this was followed within months by an amended decision to pay 75% of the amount upfront. The auditor concluded that “this shift in upfront disbursement from the earlier intended 25% to 75% has impacted the DFS’ objective to ensuring accountability for efficient and optimal use of capital”.

No lessons from the past?

The report also seems to poke a hole in the finance minister’s assumption that Rs 1.3 lakh crores of the latest recapitalisation amount would be raised through recapitalisation bonds. The Comptroller and Auditor General said in the report that when the government announced an infusion of Rs 70,000 crores under the Indiradhanush Plan, against an actual requirement of Rs 1.8 lakh crores, it was expected that public sector banks would raise Rs 1.1 lakh crores over 2015-2019 from the market. However, till March 2017, the banks had only managed to raise Rs 7,726 crores, or 7% of the total requirement, from the market, “which raises doubts on the possibility of raising the balance amounting to over a lakh crore from the market by 2019”. What if the markets and bonds fail us this time too?

The Comptroller and Auditor General identified the gaps in previous recapitalisation plans. Not learning from them would not only amount to undermining the role of the auditor, the government would also risk committing the same mistakes, resulting in the banking sector going from bad to worse.

Infusing capital into banks – reeling under the weight of a combination of bad decisions, political pressure and the inability to recover money from powerful corporations – will only work well if accompanied by robust policies for due diligence processes before lending, a free hand to banks to recover bad loans from defaulters, and a process to make the decisions of banks transparent and accountable.

Joe Athialy works with the Centre for Financial Accountability.