The banking sector is going through its worst phase. With the RBI mandating public sector banks (PSBs) to clean up their balance sheets by 2017 (by providing for non-performing assets), the already NPA strapped PSBs are in dire need of a bail-out, in addition to a well-planned and orchestrated rehabilitation programme.

With profits having taken a beating due to the addition of nearly ₹1 trillion in bad debt during the quarter ended December 31, 2015 (amounting to a 29 per cent increase in the stock of deteriorated debt from the September quarter), the higher provisioning norms shall further impact the margins in the near to medium term, thereby impeding banks' ability to access pools of liquidity at competitive rates.

The deterioration scenario has been on the government agenda, and the process of clean-up can be traced back to Budget 2015 and even prior to that.

Government’s strategy

In his 2015 Budget speech, a key amendment announced by the Finance Minister was to boost the governance of PSBs. The plan to set up an autonomous Bank Board Bureau (BBB) was conceived to formulate a strategy. The BBB shall be responsible for appointing executive directors and non-executive chairman, apart from advising on growth and rehabilitation.

This is expected to be an interim step towards ultimately establishing a holding and investment company for banks. The BBB is set to commence operations from April 1, 2016, and is a major step towards governance of state-run banks. It is clear that the government is keen to include credible and distinguished industry leaders on this platform.

The government also announced a bail-out last August with a plan to infuse ₹700 billion in the next four years. However, with the exponential surge in NPAs in the last quarter, this is not going to be enough. The gross NPAs of 39 listed banks surged to ₹4.38 trillion in the last quarter, from ₹3.4 trillion. The provisions for bad loans increased by 90 per cent in the last quarter. I would be surprised if, in the current Budget, the Finance Minister doesn’t allocate an incremental sum — the question is how much!

I expect a significant squeeze to the 2016 Budget and beyond to stem the systemic rot that has crept into the Indian banking sector.

The test ahead

To revive the sector, a standalone bail-out package would not be a long-term solution. It is more a lifeline being extended only to the banking sector, and in particular, the PSBs, which contribute to a vast majority of toxic assets. The long-term solution would have to be a combination of measures primarily aimed at reviving the traditional funding avenues such as deposits, and revival of the ailing corporate sector contributing to NPAs.

For reviving deposits, fiscal incentives in the Budget would add to the already attractive high interest environment currently prevailing. Reviving the corporate NPA portfolio is a bigger challenge and can only be a medium to long-term measure. Perhaps, that single reason makes it imperative to push the Bankruptcy Code, which will ease unclogging of NPAs.

When projects are stalled due to funding requirements, corporates look to banks to fund these needs. The banks, in turn, require higher levels of equity investment in order to provide higher leverage. The inability of promoters to raise money in times of constrained liquidity is resulting in banks restructuring their investments by converting debt into equity as per the current scheme of the RBI. This is a lost cause as ownership of ailing corporates by private sector banks with no ostensible skill to manage corporates can hardly be a step in the right direction. It can only result in the devalued sale of assets with huge losses being booked by the lenders. The Finance Minister would be better served by formulating policy measures in the Budget aimed at taking away toxic assets from the balance sheet, and housing them in separate vehicles devised for reviving them in the long run.

(Assisted by Kaushik Mukherjee and Murtaza Zoomkawala)

The writer is Managing Partner, BMR Legal. Views are personal

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