Too Little and Too Vague: Arun Jaitley’s Scheme for Bank Rescue

The Finance Minister Arun Jaitley yesterday announced a Rs. 2.11 lakh crore plan for capitalising the public-sector banks. Out of the total announced amount, the banks will get a capital of Rs. 1.35 lakh crores through recapitalisation bonds. Mr. Jaitley was vague on, who is going to issue the bonds.  Rs. 76 thousand crores  will be raised by selling banks’ shares from the market. Only a paltry Rs. 18,000 crores will be from the central exchequer. This recapitalisation is not going to be immediate, but will happen over the next two years.

Mr. Jaitely’s announcement comes in the backdrop of the prevailing NPA problems of the banking sector.

As most of us know, Indian banks have been buried under a massive pile of bad loans, or the so-called Non Performing Assets (NPAs). At present this pile of NPA amounts to more than Rs. 8 lakh crores. 70% of this, 8 lakh crore NPAs are owed by a handful of big corporates.

Public sector banks (PSBs) have been the primary victims of these loan defaults by the corporate bigwigs - as most of the NPAs are on the books of the PSBs . And, this pile of bad loans has been eating away at the foundation of the banks, which happens to be its capital.

This is where the finance minister’s announcement assumes importance – recapitalisation, theoretically at least, will strengthen the banks by providing them much needed capital.

Yet, the manner of recapitalisation that government has announced, and the amount it has declared, raises some serious questions about the government’s intentions.

The first question: why such a small amount? With an overhang of more than 8 lakh crore NPAs, it is estimated that the public sector banks would need Rs. 4.5 lakh crore of additional capital. What the government has announced is less than half of that -- that too over a period of two years --when the need of the banks is immediate.

This gives strength to the criticism that government wants to shut down some of the PSBs and merge the rest, to form a handful of large banks. By providing less capital than required, it will be forcing some of the badly affected smaller public sector banks to go under. This will have a serious adverse impact on small borrowers and depositors, who these banks cater to. There is enough evidence to show that all over the world big banks prefer large corporate customers over the needs of the ordinary borrowers and depositors.

Secondly, why should the banks be forced to raise rest or part of the Rs. 76 thousand from the market by selling its shares? Raising funds from the markets means that the shares of the PSBs will be sold to private parties. This just dilutes the stake of the government, increasing the control of private capital over the public sector banks, further paving way to the gradual privatisation of public sector banks. This is what the government and RBI have been frequently hinting at. Moreover, what happens to the smaller banks, who will find it very difficult to raise the funds in the market?

The final question – Why is Mr Jaitely cagey about revealing the manner in which recapitalisation bonds of Rs. 2.11 lakh crore will be issued? Chief Economic Adviser Aravind Subramanian’s remarks to the journalists suggest that the government is scared of increasing the fiscal deficit, by directly issuing the recapitalisation bonds.

Instead, there are suggestions that the government would float special purpose vehicle (SPV), which is going to issue the recapitalisation bonds. This would amount to a mere accounting trick, where the government’s debt will not be officially on the budget books, but on the books of a government-owned SPV.

It is time for the government to set aside its unnatural fear of the fiscal deficit and spend on the health of the public-sector banks. Even if we accept the economic logic of dangers of fiscal deficit, considering the deflationary environment in India right now, a fiscal deficit can cause no harmful inflation.

If developed countries like the USA can bail out the rich private banks with public money, why is the Indian government scared to help the publicly owned banks with public money?

There are also suggestions that banks themselves may be asked to invest part of their deposits in each other’s recapitalisation bonds. In this case banks effectively own each other’s capital. But any such scheme of diverting deposits, will squeeze credit to the already credit starved economy.

There are even suggestions that public financial institutions like LIC should be asked to subscribe to the recapitalisation bonds issued by the banks. Under any such scheme, banks will be paying interest on these bonds, adding an additional burden on them in the present circumstances.

Instead of breaking their heads about how to juggle the books and hide the fiscal deficit, the country would be better served if Mr Jaitely and his government concentrated on bringing to book, the corporate bigwigs who have defaulted on loans given by the public sector banks. India’s corporate bigwigs (India’s 100 richest people), during the 3 years of BJP regime have amassed an additional wealth of Rs. 8 lakh crore. Incidentally, Rs. 8 lakh crore is also the value of bad loans, which the companies owned by many of them, owe to the banks.

Clearly, recapitalisation will not serve the purpose,  if these corporates are allowed to continue to loot public sector banks at will. It is time the government brings the big corporations to heel and holds them accountable for their debts to the banks.

Disclaimer: The views expressed here are the author's personal views, and do not necessarily represent the views of Newsclick.