India’s state-backed banks are threatening the country’s financial system. Stressed loans held by these lenders have increased on average to nearly 14% of assets and the figure is predicted to rise further this year. Add to that the fact that state-owned banks, also referred to as PSU banks, control nearly three-quarters of the lending and the problems are only set to grow.
The government is certainly paying heed to the numbers and taking steps to right the ship. In February it announced an injection of additional capital only into lenders that met specific profitability criteria — meaning just five PSUs made the cut of the total 27 listed state-backed names.
Fast forward five months and India has now backtracked from its original plan. Instead, on July 31 it said it would infuse Rp700bn ($11bn) into all of its PSUs over the next four years, of which Rp500bn would be provided over the first two years. With this change of heart, India is hoping all state-controlled banks will have a tier one capital ratio of at least 7.50% by March 2016.
Its ambitions are lofty, especially as by its own calculations banks need a staggering Rp1.8tr over the next four years to comply with Basel III requirements. But its approach is foolhardy and doesn’t tackle the core of the problems in India’s banking system.
One area where India is not doing enough is in solving the problem of existing distressed loans. Banks are continuing to roll over debt that is likely never to be repaid and the government is yet to push lenders to start writing down bad loans.
India also boasts far more banks than required, with the smaller ones needing more government support. Pushing for consolidation among smaller banks — or even outright privatisation — will give some much-needed comfort to the market.
The government also needs to keep in mind that if it constantly bails out troubled banks, it will end up creating a moral hazard where PSUs will expect the authorities to always jump in and save the day.
What the country needs to do instead is push lenders to raise capital from the equity markets, even if it means having to pay up to get deals done. Even with the capital injection, PSU banks have to access ECM anyway to meet their tier one requirements, so setting the stage for that sooner rather than later will help. If lengthy roadshows and juicy discounts are required to woo investors, so be it.
Sure, the response may be tepid for smaller issuers but India will only get a true sense of demand if it starts to test the market’s appetite. Investor feedback will make survival of the fittest banks even more important and push the country to weed out weak lenders through consolidation.
The journey forward is tough, but India can make it comfortable if it starts thinking about long-term solutions to its distressed banks rather than quick fixes. If debt levels escalate, the government will be forced to inject more capital into banks, leading to an even bigger vicious circle.
India may have thrown a temporary lifeline to its banks. But if it wants to keep its financial system afloat, it might make more sense to let some of its state-owned lenders sink.