India mulls recap bonds to tackle banks’ capital shortfall
The possible return of recapitalisation bonds after a two decade absence could help India tackle a triple threat of a stressed banking sector, rising leverage among corporates and challenges to the public financial system
The idea of issuing recapitalisation bonds is rearing its head in India, more than two decades after the country first sold such notes, as the authorities look for solutions to fix the capital shortfall problems ailing state-owned banks.
India is facing a triple threat in the form of a stressed banking sector, rising leverage among corporates and challenges to the public financial system. But at least on the first issue, it appears to be nearing a solution.
“India last sold recapitalisation bonds in 1995, but it is now being seriously considered by the government to boost capital among state-owned banks,” Rajnish Kumar, the new chairman of State Bank of India, the south Asian country’s largest bank, told GlobalMarkets.
Recapitalisation bonds certainly make sense. India’s banks are flush with liquidity, receiving an additional fillip recently from the government’s landmark demonetisation drive. On the flip side, demand for credit is very low, resulting in banks finding other avenues to use their money, including by pumping funds into the debt market.
Marrying the two through recapitalisation bonds is a win-win for both the government and the beleaguered public sector banks, which are facing a capital shortfall of as much as $14bn. The government will effectively sell the bonds to the banks, and use the proceeds to inject equity capital into the banks. This means the notes are not reflected in the government’s balance sheet, thereby not raising its fiscal deficit — an appeal for the country.
Kumar added that if recapitalisation bonds became a reality, the government should rake in the necessary proceeds in one go, rather than as a piecemeal process.
No free lunch
But an economist at the Indian arm of an international ratings agency reckons the move reeks of desperation. “It’s not a free lunch situation,” he told GlobalMarkets. “In the end, the risk remains within the system. It will just look good on the government’s part because the banking system looks like it has improved.”
India has been struggling to revitalise its banking industry, which has clearly had an impact on its growth. On Friday the IMF revised India’s growth forecast for the 2017 financial year down to 6.7% and to 7.4% in FY2018 — a direct result of structural weaknesses in the corporate and banking sectors.
However, the broad expectation is that growth will pick up soon enough.
“The favourable outlook for Asia, including India, provides an important opportunity to push for reforms,” Kenneth Kang, deputy director, Asia and Pacific department at the IMF, said. “[India should] address the corporate and banking sector weaknesses by accelerating the resolution of non-performing loans, rebuilding capital buffers for public sector banks and enhancing banks’ debt recovery mechanisms.”