The government’s announcement yesterday on the Rs. 2.11 lakh cr. recapitalisation package for public sector banks was the need of the hour. With stressed loans climbing up to Rs. 10 lakh cr and increased provisioning requirements arising out of the ongoing recovery proceedings, public sector banks need a large infusion of capital over the next two years to maintain their capital adequacy in line with Basel III norms. On the other hand, the domestic infrastructure sector along with the MSMEs would require significant funding from banks to capitalise on the opportunity being created through favourable policies in these segments.

Public sector banks (PSBs) have been facing asset quality and capital adequacy challenges for the last few years. The financial health of PSBs has continued to deteriorate despite regular capital infusion from the government with increasing provisioning requirements on the stressed assets. Seven PSBs are currently under prompt corrective action (PCA) mode with risks of breaching the minimum capital adequacy norms under Basel III. Clearly, there was a need to take a bold step like the proposed recapitalisation package to revive the public sector banking system and provide comfort to investors of these banks.

Many of these banks have raised hybrid capital through the issuance of additional tier-1 bonds over the last three years and investors in these bonds had concerns over the serviceability of these bonds, given the banks’ weakening capital position.

One of the key factors in the growth weakness witnessed in the economy has been a slowdown in bank credit growth. As on end September 2017, the year-on-year bank credit growth stood at 6.9% as compared to 10.1% in the corresponding period of the previous year. Market studies undertaken by SMERA suggest that the lack of credit growth cannot be attributed to the lack of credit demand. It is also a fallout of capital constraints and increased credit aversion. With the announcement on recapitalisation, public sector banks have an opportunity to re-capture the market share they have been losing to private sector banks and NBFCs in both the corporate and the MSME segment. The government has also announced its plans to step up investments in the infrastructure sector and this would clearly require funding from the PSBs.

Additionally, this is the right time to renew focus on building a robust MSME ecosystem and lend to those units starved of funds. The situation is particularly worrisome in this sector as bank advances have been virtually stagnant at Rs. 4.7 lakh cr in over the last three years.

However, SMERA believes that the recapitalisation plans in the public sector banks need to be accompanied by continued banking reforms to ensure sustainability of these banks. Independence of the banks’ boards, induction of private sector professionals in the banks’ management and stronger risk management systems are some of the steps that need to be taken as part of these reforms. The banks need to work closely with external and independent agencies to overhaul their credit appraisal as well as credit monitoring mechanism. There should also be an appropriate incentive mechanism for banks and their management to step up their lending to the productive sectors of the economy and the MSMEs in particular.