Banking Re-capitalisation has failed to contribute meaningfully to credit growth, says Ind-Ra

BiznextIndia : While the government is re-capitalising the public sector banks, a research report said that it has failed to contribute meaningfully to credit growth.
“It is time to reevaluate the objectives of public sector banks (PSBs) and their role in the Indian economy. While the government has infused huge capital in PSBs, the same has largely been used to mitigate losses and has failed to contribute meaningfully to credit growth” said the report by India Ratings and Research (Ind-Ra).
During FY14-FY19, the government and Life Insurance Corporation (LIC) together infused INR3.0 trillion in PSBs. However, from the value creation objective, the scenario looks weak. The current market value as on 29 July 2019 of government and LIC’s stake was INR4.4 trillion (FY14: about INR2.2 trillion). The increase in market capitalisation over FY14 is significantly lower than the capital infused. Nine of 19 PSBs reported current value of investment higher than the investment amount. The key banks among them are Indian Bank (INDIAN; ‘IND AA+’/Stable/’IND A1+’), State Bank of India (SBI; ‘IND AAA’/Stable), Bank of Baroda (BOB; ‘IND AAA’/Stable/‘IND A1+’) and Canara Bank (CAN; ‘IND AAA’/Stable).

The sharp deterioration in asset quality in the last few years led to accelerated provisions among all PSBs. This caused banks to suffer massive losses, which in turn led to failure in meeting objectives of the Indradhanush Scheme such as recapitalising banks based on their performance and their ability to support credit expansion. In reality, the capital infused was largely consumed to tide over losses resulting from provisions required on non-performing assets.

Over the years, the market share of PSBs in incremental credit generation shifted to other market participants including private banks, foreign banks, non-bank financial companies, housing finance companies and mutual funds. The market share of PSBs fell to 46.5% in FY19 from 60.9% in FY14. More importantly, in terms of incremental credit, the share of PSBs has been 26.2% over FY14-FY19.

The objective of nationalisation of banks included financial inclusion as the primary objective, along with increasing availability of credit to priority sectors such as agriculture and small and medium enterprises (SMEs). Due to stress of bad corporate loans in the system, the incremental credit to agricultural and SMEs segments by PSBs has been only 1.3x-1.5x of incremental credit to agricultural and SME segment by top 6 private banks (by the size of its assets) i.e. significantly lower than the share of PSBs in the banking system. Anecdotal evidence suggests PSB’s share in funding direct small ticket lending to agri and other priority sectors still remains high.

Recapitalisation is a prompt response to infuse funds in cash-strapped public sector banks. The capital infusion by the government in PSBs may ensure banks’ solvency but may not necessarily ensure stability and growth in the absence of non-financial and structural reforms. Some of the structural changes that Ind-Ra believes should be implemented at the earliest include: 1) increase the tenure and prevent frequent changes in senior management team of PSBs as this does not allow for continuity in management policies and also reduces accountability; 2) include variable compensation and grant employee stock options to directly link the performance of the bank with the performance of the management team; 3) allow appointment of candidates from the private sector; some progress has been made towards this with the appointment of managing director and CEO for BOB, and more of this needs to be done to improve the management depth; 4) improve governance and increase independence of the board, 5) capability building and introducing compensation programmes in the staff to bring their drive for business at par with private banks, 6) use and adapt intelligent technologies to source business, manage loan workflows, reduce operating costs and reduce subjectivity in sanctions.Without structural reforms in place, the government will have to continue to inject capital into banks in times of stress, which will strain its own finances and hinder efforts for fiscal consolidation.