What is Recapitalisation of Public Sector Banks

‘If we can fill up that hole with capital, we’re good to go not only with existing provision numbers but for even the Basel requirements that come in later.’

Recapitalization is described as a strategy of enhancing the financial base of an equity to overcome a rough financial situation or to enhance its financial health. The recent issue of recapitalization bonds by government is proactive step in the development of economy. Recapitalization is very successful in many countries and in India, in the past.

Bank Recapitalization is a must needed step for jurisdiction of public funds. The benefits of such exercise are difficult to quantify as they relate to avoiding disruptive effects that are qualitative in nature. Recapitalization was necessary because the PSBs are facing financial problems and they need money in the context of rising bad debts. The three sound reasons for recapitalization of PSBS are as follows:

a. Rising volume of bad assets has led to erosion of capital

b. The Basel III capital norms requires higher capital in banks

c. Expanding credit needs in the economy can be made only with higher capital.

The government has announced a major recapitalization drive on October 24, 2017 by utilizing three channels- budget, market borrowings and issue of recapitalization bonds. The Rs. 1.35 trillion package is largely adequate by the ministry of finance estimates. The latest figures put the increase in non-performing assets (NPAs) from financial year (FY) 2015 till June 2017 at Rs. 4.55 trillion. The increased provisioning in the time period 2014-15 to 2017-18 is pegged at Rs. 3.79 trillion. So, the banking sector recapitalization to the tune of Rs. 2.11 trillion seems sufficient for tackling the problem of stressed assets. Additionally, after provision for bad assets and on a conservative basis, even if 50% remains as a residual for growth capital of banks, the multiplier impact may be significant.

The latest effort of recapitalization will rejuvenate the banking sector. This will help banks to extend fresh credits and to sort out the stressed asset problem to an extent. At the same time, it is not indiscriminate as banks themselves must commit performance improvement measures by signing memorandum of understanding with the government.

BJP chief Amit Shah described the government’s announcement of Rs 2.11 trillion for bank recapitalization as “historic” and said it will not only give impetus to businesses but also provide employment to the youth.

Ultimately, this recapitalization will lead to an improvement in the government’s finances as it would be able to sell its stake in public sector banks at much higher valuations (market capitalization went up to Rs 1.2 trillion in a single day). Even on the demand side, some banks who were not investing their extra cash into debt securities due to capital shortage may now be able to do so instead of placing them with the Reserve Bank of India’s reverse repos.