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Do banks have enough capital to lend in case India witnesses an economic recovery later this year? The answer is a clear no as minimum capital requirements are set to rise and mid-cap public sector banks do not have so much capital

By Shantanu Guha Ray


Bureaucrats from the fina-nce, commerce and agriculture ministries got the shock of their lives at a recent seminar. Here, seasoned economist and former chief economic advisor Arvind Virmani said he had a feeling that the recent call of the RBI to cut rates would get more strident. As an advisor of the bank, Virmani had insider information and all believed him when he said there was room of 1.25 percentage points more for a policy rate cut.

And then came the bombshell. He asked: “For the moment, can we forget the high level of lending rates. Do banks have enough capital to lend in case India witnesses an economic recovery later this year?”
No answers were forthcoming.

DIRE SITUATION?

Even if someone had replied from the audience, the answer would have been negative, ostensibly because the minimum total capital requirements in India are set to rise this financial. As per RBI’s timeline to push Basel III norms (these relate to risk management in banking), which Indian banks hardly follow, banks operating in India must make provisions for a capital conservation buffer of 0.625 percent of risk-weighted assets by the end of the financial. This, in short, means—as per calculations done by RBI—that the minimum capital requirement would increase to 9.625 percent this fiscal and increase to 10.25 percent next year. Therein lies the biggest problem for India.

“In India, big banks like the State Bank of India, Bank of Baroda and Punjab National Bank are sitting comfortably with good capital stocks. But the situation is not so rosy for mid-cap public sector banks,” says Sudipto Mundle, emeritus professor at National Institute of Public Finance and Policy. He added that mid-cap banks account for around one-third of bank credit. “Where will the cash come from?” he asked.

As per the calculations done by the Reserve Bank of India, the minimum capital requirement in banks would increase to 9.625 percent this fiscal and further increase to 10.25 percent next year.

It is estimated that the credit gap for the Micro, Small and Medium Enterprises (MSME) sector will increase from `10,15,614 crore at the beginning of the 12th Plan (April 2012) to `11,37,151 crore at the end of the 12th Plan (March 2017). Reasons for low credit penetration among SMEs range from insufficient credit information on them to their low market credibility.

Now if SMEs do not get cash, does that— in reality—mean India is heading for a credit starvation phase by the end of this year? Probably yes.

BANKS IN TROUBLE

As per recent calculations from India Ratings and Research, mid-level Indian banks will need a whopping `1.6 trillion in capital by 2019 to match Basel III requirements. “But who will give the capital? For the moment, there seems to be little chance. Worse, with high credit costs and low loan growth, contributions from retained profits are abysmally low,” says Mundle.

“In India, big banks like the State Bank of India, Bank of Baroda and Punjab National Bank are sitting comfortably with good capital stocks. The situation is not so rosy for mid-cap public sector banks.” — Sudipto Mundle, emeritus professor, National Institute of Public Finance and Policy

The finance ministry cannot help, it is amply clear, argues Professor Makkhan Lal, a distinguished fellow at Vivekananda Inter-national Foundation, a Delhi-based think-tank. He has statistics to support his argument. For the record, only `7,940 crore has been earmarked for bank re-capitalization this fiscal. As against this, `7,000 crore was infused, lower than the budget target of `11,200 crore. The policy for bank recapitalization is whimsical. Last year, it was based on performance and this year, it will be based on individual needs of lenders.

Lal says the bulk of PSU banks are trading below book values, hence raising money from capital markets will be a tough proposition. Worse, the government will not cut its stakes. “What will happen is very clear, credit growth will be hurt,” says Lal.

“In India, big banks like the State Bank of India, Bank of Baroda and Punjab National Bank are sitting comfortably with good capital stocks. The situation is not so rosy for mid-cap public sector banks.” — Sudipto Mundle, emeritus professor, National Institute of Public Finance and Policy

In the absence of government capital infusion, India Ratings’ projections claim average annual bank credit growth over the next four years could plummet as low as 6.35 percent. Even if the RBI and finance ministry pump in half the required capital, credit growth would be tepid at 10.8 percent.

Virmani says India’s better-capitalized private banks will not take up the slack, unwilling to bear the burden. The ones affected would be PSU banks which lend across the spectrum—from farmers to textile companies to SMEs—as compared to private lenders who tend to focus more on consumer finance and corporate lending. “Eventually, small and marginal sectors will face the specter of credit starvation in India if bank capital isn’t forthcoming,” warns Virmani.

OMINOUS SIGNALS

What is distressing is that there are no shortcuts to resolve the crisis. A deficient monsoon, unseasonal rains and hailstorms destroyed crops last year and now a new monsoon forecast predicts a below-normal monsoon in 2015, putting the Indian farm sector in a real fix. Worse, this has triggered increased farmer suicides—3,000 so far.
India Ratings states that the crop damage caused by the untimely hail and rain in March 2015 may hurt the asset quality of India’s farm credit. This is a body-blow to both farmers and the banks. Regionally concentrated banks with a large rural presence in the affected regions are at high risk, claims India Ratings.

2

It is highly possible that small and medium enterprises may not get loans from the banks
in future

The banks have pushed their agriculture loans lately, prompted by the ruling NDA’s decision to promote farm loans to help farmers. The lower credit demand in other sectors could also be considered a reason for aggressive farm lending. “But unseasonal rains slowed agriculture credit growth. Loans grew 16 percent YoY (Year on Year) in FY15 due to government’s promotion of agricultural loans and lower credit demand in other sectors,” says Mundle.

As per government records, bank credit growth for FY15 (12.6 percent YoY growth for total credit) was driven by the farm sector that contributed 25 percent to the incremental growth in the system in 2014-15. Finance minister Arun Jaitley targeted 6.3 percent YoY growth in banks’ credit to the agriculture sector, but actual growth may slow down as banks continue to grapple with the routine deterioration in farm loan asset quality. A final picture should emerge by June-end.

UNEASY SHIFT

Lal says that if agriculture lending slows down, banks in India could shift their loanable funds to alternatives, such as the Rural Infrastructure Development Fund to meet priority sector requirements. “But it is easier said than done because the switch from the higher yielding agricultural loans to the development fund will invariably impact profitability even further,” says Lal.

As per government estimates, system-wide agricultural non-performing assets (NPA) as a percentage of total agricultural advances will increase to 16.9 percent in 2015 from 13 percent in 2014 due to unseasonal rains. These heavily exposed individual banks may also see their agriculture NPA levels increasing more than double and the system-wide impact will be a 40 basis point increase in gross NPA ratios on total advances. Mundle says the profitability impact of these stressed agricultural loans indicates a higher asset depletion.

Kshtrapati Shivaji, chairman, Small Industries Development Bank of India also feels Indian banks are not in a happy condition. He says they have high-stressed assets that amounted to 10.6 percent of total credit at end-December 2014 and are expected to increase to 13 percent by end-March 2016. And if rains are untimely, this could cross 14 percent. “The pressure is high on smaller banks, they will have to find a way out of this crisis because SMEs are crucial to India’s growth story,” adds Shivaji.

Someone needs to find a magic wand to end the bad times. The toss is between Rajan and Jaitley.

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