Recapitalization of Indian Banking System

Recapitalization is a strategy for enhancing the financial base of an entity to overcome the rough financial situation or to enhance its financial health. In India, Recapitalization of Indian public banks is not a new phenomenon; India has adopted this strategy in 1993-94 under the finance ministry of Dr. Manmohan Singh. 

The main reasons for the recapitalization of Indian public sector banks are:

1. Stringent capital adequacy requirements imposed by RBI in the wake of the Basel III norms, 
2. High levels of NPAs and the poor performance of PSBs have led to significant capital erosion and requirements for further capital—both for replenishment of the base eroded by NPAs and fresh ones for giving loans.

There are ways and methods of adopting recapitalization techniques in general, however, to be precise the proposed recapitalization package for Indian Banking System combines various desirable features:

1.  Deploying recapitalization bond - it will front-load capital injections while staggering the attendant fiscal implications over a period.
2. Private Participation - It will involve private shareholding participation by market funding.
3. Recapitalization Programme - Indradhanush Scheme is introduced to give overall restructured reform to banks.

From the above packages, the Indian Government and Central Bank i.e. RBI will infuse Rs. 2.11 trillion capital which roughly has a 70% share of the assets of Indian banking industry, consisting of 21 public sector banks, 26 private sector banks, 43 foreign banks and 56 regional rural banks. (As per Live Mint Wed, Jan 10, 2018. 06 05 PM IST) Of this, Rs1.35 trillion will come from the sale of so-called recapitalization bonds and the remaining Rs76, 000 crores will be through budgetary allocation and fund-raising from the markets, in addition to it, this strategy is backed by Indradhanush scheme which mainly concerned with the management aspects of Banks.

To evaluate the performance of banks from 2008-2016, after capital infusion, the Department of Financial Services (DFS) classify public sector banks in two categories namely I and II as per the percentage of their then net-worth to capital infusion. 

• Category I: PSBs, which received capital infusion during 2008-16 below 25 percent of their net worth (as on 31 March 2016).  12 PSBs, - Allahabad Bank, Andhra Bank, Bank of Baroda, Canara Bank, Corporation Bank, Indian Bank, Oriental Bank of Commerce, Punjab & Sind Bank, Punjab National Bank, State Bank of India, Syndicate Bank and Union Bank of India, fell into this category. 
• Category II: PSBs, which received capital infusion during 2008-16, 25 percent or above 25 percent of their net worth (as on 31 March 2016) 9 PSBs, - Bank of India, Bank of Maharashtra, Central Bank of India, Dena Bank, IDBI Bank, Indian Overseas Bank, UCO Bank, United Bank of India and Vijaya Bank, fell into this category. 

Recapitalization – Schemes and Initiatives 

Recapitalization Bonds 

A bond is a financial instrument used to raise money from the markets. If someone buys a government bond, for example, the investor hand over a certain amount of money in return for regular interest payments along with the expectation that the government will repay the amount in full at a certain point of time. In a way, it is like giving a loan to the government. However, bank recapitalization bonds are slightly different. These are bonds issued by the government to which banks can subscribe – and they are specifically aimed at banks that have a lot of deposits on hand. According to Reserve Bank of India estimates, the total excess deposits accrued to the banking system due to demonetization was in the range of Rs. 2.8 lakh crores to Rs 4.3 lakh crore. It is these excess deposits that the banks are expected to use to buy the recapitalization bonds. The government is likely to use the money raised by the sale of these bonds to increase the number of shares it holds in the banks. This will give the banks more capital to work with, making it easier for them to offset the effect of writing off bad loans. Bonds worth of Rs 1.35 trillion is issued to inject capital into PSBs affected by high level of NPAs. In other words, the term recapitalization means giving equity money to cover debt of an entity. In the case of PSBs, their NPAs (debts) will replace by equity capital from recapitalization by the government. 

There are various features involve in Indian Recapitalization bonds such as bonds will be issued in six lots with different maturities from 10yrs to 15years and with coupon from 7.35% to 7.68%, these bonds will be part of held-to-maturity (HTM) portfolio without any limit but non-transferable and so. 

Indradhanush Scheme   

The Indradhanush framework i.e. seven-pronged plan unveiled on August 14, 2015, for revamping Public Sector Banks (PSBs) of India. Mission Indradhanush is a comprehensive plan for recapitalization of public sector lenders, with a view to make sure they remain solvent and fully comply with the global capital adequacy norms, Basel-III.  The 7 elements of Indradhanush Scheme are Appointments, Banks board bureau, Capitalization, De-stressing, Empowerment, Framework of accountability and Governance reforms (ABCDEFG)

1. Appointments : separation of posts of CEO and MD to check the excess concentration of power and smoothen the functioning of banks; also induction of talent from the private sector 
2. Bank Boards Bureau - will replace the appointments board of PSBs: It will advise the banks on how to raise funds and how to go ahead with mergers and acquisitions. This BBB will be a step into an eventual transition of the bureau into a bank holding company and will separate the functioning of the banks from the government by acting as a middle link. The bureau will have three ex-officio members and three expert members, in addition to the Chairman.
3. Capitalization: Capitalization of the banks by inducing Rs. 70,000 crore into the banks in the next 4 years. Banks are in need of capitalization due to high NPAs and due to needing to meet the new Basel- III norms
4. De-stressing : Solve issues in the infrastructure sector to check the problem of stressed assets in banks
5. Empowerment : Greater autonomy for banks; more flexibility for hiring manpower
6. Framework of accountability: The banks will be assessed on the basis of new key performance indicators. These quantitative parameters such as NPA management, return on capital, growth, and diversification of business and financial inclusion as well as qualitative parameters such as human resource initiatives and strategic steps to improve assets quality.
7. Governance Reforms: GyanSangam conferences between government officials and bankers for resolving issues in the banking sector and chalking out future policy.

The article evaluates the performance of Banks through Credit Growth, Return on asset, return on equity, Non-Performing assets, with respect to category I and II. 

Credit growth in India has seen a declining trend over the last three years due to decline in economic activity leading to the moderation in industrial output, leveraged corporate balance sheets and low capital expenditure (CapEx) plans resulting in a decline in credit demand and asset quality overhang making banks cautious in lending. Whereas, After the capital infusion, According to Financial Services Secretary Rajeev Kumar, the banking sector posted double-digit growth on a year-on-year basis in December 2017. Banking sector posts double digit (10.7 percent Y-o-Y) growth in Dec'17, up from (7.2 percent Y-o-Y) in Oct'17, powered by services and retail. (MOF, 2017)

Return on Assets of a PSB is a financial ratio, which measures net income as a percentage of average total assets of the bank. It indicates how efficient the management of the bank is, at employing its assets to generate profits.  Return on Equity of a PSB is the ratio of net profit to shareholders' equity. This ratio is monitored by the market as shareholders of the bank track ROE, which is an indicator of the bank’s performance. As the bank under-performs, its ROA and ROE go down. A low or negative ROA/ROE of a bank indicated its reduced ability to generate profits internally. As a part of the profits goes to enhance the bank reserves (post-payout of dividends) and hence capital, this implies lower/ non-enhancement of reserves/ capital. Besides, a falling ROA/ ROE reduce market confidence and make it more difficult for the bank to raise capital from the market. 

As per RBI Annual Report 2017, under both category i.e. I and II ROA and ROE is progressively decreased, the average ROA and ROE of category II banks are lower than category II, as an ROA of category II banks was -0.59% vis –a-vis -0.10% in category I in FY 2016 while ROE of category II banks was -9.44% vis –a - vis -1.77% in category I banks in same year. Thus a higher proportion of capital infusion compared to networth has not translated into better profitability of banks (RBI, 2017)  

The capital adequacy ratio (CAR) is a measure of a bank's capital. It is express as a percentage of a bank's risk weighted credit exposures. Also known as, capital-to-risk weighted assets ratio (CRAR), used to protect depositors and promote the stability and efficiency of financial systems around the world. One of the primary objectives of GOI capital infusion in the PSBs was a maintenance of the capital adequacy as per regulatory requirements (Basel norms/ RBI norms). One can compare the Capital to Risk Weighted Assets Ratio (CRAR) or Capital Adequacy Ratio (CAR) of both categories of PSBs. As per data from RBI, the average CRAR of category II banks have consistently lower than that of category I banks even after the relatively higher proportion of Government capital infusion. 

To conclude, Reorientation of the Indian banking sector will not be a discrete, one-time event, but a continuous, endogenous process that matches the structural changes taking place in the Indian economy. It is still hard attempt to evaluate the performance of Public sector bank with reference to recapitalization wave. We can also conclude looking at the evidence that the argument of the sufficiency of the amount of capital infusion, The Rs 1.35 trillion packages in it seem largely adequate going by the ministry of finance estimates. The latest figures show that the increase in non-performing assets (NPAs) from the financial year (FY) 2015 until June 2017 at Rs4.55 trillion. The increased provisioning in the period 2014-15 to 2017-18 is peg at Rs3.79 trillion. Therefore, 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.