Bank Recapitalization: a Lesson from 1993 (Important) (Download PDF)

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Indian government announced Rs. 2.11-lakh-crore capitalization plan for state-owned banks over two years, which solves two problems: Government’s approach insists on resolving the banking sector problems of NPA’s by infusing a huge amount of capital.

Image of Bank Recapitalization

Image of Bank Recapitalization

Image of Bank Recapitalization

  • This funding will not affect the fiscal deficit and is funded through “recapitalization bonds. “

History Lesson

  • Approach first tried out almost 25 years ago when economy was in repair in 1992 - 93 after the balance of payments crisis in 1991 - 92

  • Government unveiled reforms in the financial sector especially after the securities fraud of 1991 - 92.

  • Cash-strapped government made provisions against bad loans of over Rs. 10,000 crore- Manmohan Singh, the then Finance Minister, provided in his 1993 budget, Rs. 5700 crore to public sector banks.

  • Government issued bonds to infuse capital into banks with no cash outgo- the government’s liability was limited to the interest payment on the bonds and their final redemption.

Details of the Recapitalization Process

  • First government gives money to banks

  • Banks, in turn, buy or subscribe to bonds issued by the government at a fixed coupon or interest linked to market rates for a specified period, 10 or 15 years or longer.

Why Are Such Recapitalization Bonds Useful?

  • These bonds are counted as Tier One or Core capital of banks, critical to maintaining globally accepted standards of capital for banks, which, today, is 9 per cent of their total loans, investments and other assets after factoring in risks against each of these.

  • When bad loans deplete the capital of banks and inhibits their ability to lend, banks can rely on these bonds for liquidity.

  • Government running a deficit but is committed to spending on roads, ports and social welfare measures, doesn’t have cash to infuse as capital- the bonds come in handy.

  • Bonds provide capital for banks and interest on becomes an income for lenders- when growth picks up, the lenders are in a position to lend afresh.

Costs for Government

  • On Rs. 1.35 lakh crore worth of recapitalization bonds, the interest payment could range between Rs. 8000 to Rs. 9000 crore annually

  • The tangible cost is offset by “confidence impact” of having addressed the issue of lending, boosting credit supply, private investment, and growth.

Image of Recapitalization

Image of Recapitalization

Image of Recapitalization

Do the Bonds Add to Fiscal Deficit?

  • Government is committed to a fiscal deficit of 3.2 per cent in FY18.

  • Although IMF accounting norms say that recap bonds do not increase the deficit but under India’s convention, these bonds would add to the deficit.

Probable Impact of Recapitalization

  • Theoretically, recapitalization should lead to more lending by banks

  • It is unlikely to increase loan demand because of the low demand for credit now.

  • Capital infusion or fiscal stimulus could ensure a multiplier effect- after banks use part of the funds to provide for bad loans, a good chunk will still be available for growth capital.

  • It will enable PSU banks to compete better down the line.

  • Capital infusion would lead to interest rates fall.

- Published/Last Modified on: November 27, 2017

Economy

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