Front Loading PSB Recapitalisation Good Idea; Economic Growth Cannot Wait For Banks To 'Reform Management'

The Union government recently took the decision to recapitalise banks using the recap bonds. The move will infuse Rs 20,000 crores in India’s public sector banks (PSB) that may witness a deterioration in their balance sheet due to the present pandemic.

The approach towards recapitalisation is one that must be applauded, especially since it has come well ahead of the deterioration of assets. Moratoriums and other measures did help in preventing massive bankruptcies, and now the RBI is looking at the restructuring guidelines as another intervention which could help banks prevent large-scale deterioration of their assets.

However, at some point, there will be some deterioration and consequently, PSBs will invariably have to be recapitalised. The move to infuse Rs 20,000 crores is thus pre-emptive and should serve as a signal to banks that the government is willing to act in order to provide a cushion against the impact of the pandemic on India’s financial system.

Many have, however, criticised the move and highlighted how government has successively infused capital into the PSBs while they have continued to struggle. That we keep using taxpayer’s money to bail out the banks which tend to make poor lending decisions is a fair point – and one that requires comprehensive reforms of the banking system. In fact, there is a need to improve overall corporate governance in general in the country – however, the same cannot be a project at the expense of economic growth.

Needless to say, not providing banks with the funds would have had significant adverse consequences for credit creation, and consequently, economic growth. Therefore, the prudent policy option was to combine the bank recapitalisation with broader governance reforms. The former happened, while we wait for the latter.

One of the important things to remember is that government at present is dealing with an unprecedented economic situation and maintaining financial stability is critical for a speedy economic recovery. Consequently, front-loading of recapitalisation will ensure that banks have adequate capital to provision for any loses and continue to provide credit to the economy. It has become increasingly obvious that a swift economic recovery would largely depend on the banks and their ability to lend to companies to tide over the present crisis.

It is further refreshing to see that government has – unlike before, recognised a deterioration in balance sheet of banks early on. This is in contrast with the way it handled the NPA situation during its initial years post 2014. Unlike then, we saw front loading of recapitalisation in 2019 and yet another round of recapitalization in 2020.

There are prospects of a fresh round of recapitalisation in 2021 which would probably come as a part of the budget which would further provision for any more losses that could emerge due to the pandemic.

The approach of getting ahead of the curve and addressing the problem is important as it will be a key factor in determining the pace of economic recovery – that is, if banks lend and businesses go back to being operational at pre-COVID levels then we should see a sharper recovery in the next financial year. In the event of banks continuing to be risk averse, we will witness shallow economic recovery in the next financial year. This is precisely why the front loading is essential.

The most important point in the entire exercise is that the government has recognised the mistake of kicking the can down the road on recapitalisation.