Budget unveils steps to relieve stress on banks

By Babu Sivaprakasam, Deep Roy and Sharmila Ratnam, Economic Laws Practice
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The government’s budget for the year 2016-17 is considered to be extremely critical for the banking industry, especially the public sector banks. The Reserve Bank of India (RBI) had conducted an asset-quality review across the banking sector and had asked banks to recognize visibly stressed assets as non-performing assets (NPAs) and make provisions for them.

In the light of such provisioning (which may not be for all NPAs, as provisioning was to be carried out over the two quarters ended in December 2015 and March 2016), 12 of the public sector banks posted losses in the December quarter. The gross value of their NPAs rose by ₹1.3 trillion (US$19.35 billion) in the three months ended 31 December to a total of ₹3.93 trillion.

Recapitalization

The budget re-emphasized the need for a strong and well-functioning banking system and stated that the government will continue supporting the banks. As part of a larger comprehensive Plan for Revamping of Public Sector Banks, dubbed Indradhanush, which was launched in 2015, the budget proposed an allocation of ₹250 billion in 2016-17 towards re-capitalization of public sector banks.

Babu Sivaprakasam
Babu Sivaprakasam

This is the first step towards a phased four-year capitalization of the public sector banks for an aggregate amount of ₹700 billon. However, it had been expected that the government would provide for a lot more, considering the increasing amount of provisioning being required for stressed assets.

The inability to realize certain assets, the increase in provisioning and the reduction in profits are affecting the banks’ ability to do business. The statistics clearly show that the present amount will not be enough to resolve the public sector banks’ capital issues. Considering the disparity between the amount set aside by the government and the massive required clean-up to banks’ assets, the government has to devise other strategies.

Other boosts

Soon after the budget, the RBI eased regulations to strengthen the banks’ core capital. Revaluation reserve linked to property holdings, foreign currency assets and deferred tax assets is to be counted while calculating tier-1 capital, thereby providing a slight breather. It has been indicated that this change will help banks meet Basel III capital norms and International Financial Reporting Standards.

Deep Roy
Deep Roy

In the current scenario, the government has clearly identified that asset reconstruction companies (ARCs), stressed asset funds and asset reconstruction divisions of existing financial institutions will hold the key and ease the stress being faced by banks. Noting this, the budget allowed the sponsors of ARCs to retain a 100% stake and also proposed an increase in the foreign direct investment cap for ARCs. This will help draw more funds into the ARCs in two ways: (i) promoters will be able to have the entire stake and therefore have the entire risk and reward; and (ii) foreign investors will be able to invest for a higher stake and will also have the comfort of exiting by selling the entire stake to the promoter.

Consolidation

The government has also indicated that it will continue its efforts towards consolidation of public sector banks and will be aided in this by the Bank Board Bureau, which is to come into operation in 2016-17. The government is looking to reduce its stake in public sector banks and invite the private players to buy in. This would provide additional capital to the government.

Allowing the private sector to subscribe to new instruments of banks will allow the consideration to directly flow into the banks. However, we understand that such stake sales will be in moderation. Privatization of the banking sector is not always considered beneficial for a nation. The financial crisis in the US was caused by bankruptcy of private financial institutions.

Conclusion

The bigger question is why there is such a surge in stressed assets and what is being done to address the stressed assets situation? Recognizing this issue, the Supreme Court of India on 16 February asked the RBI to furnish details of companies that have each defaulted on loans amounting to more than ₹5 billion.

There are several reports suggesting that the debt-recovery mechanism is extremely time consuming and accordingly enforcement of security takes considerable time. The budget has also recognized that adequate steps are required to be taken to hasten the process of adjudication at the debt recovery tribunals. It is imperative to deliberate and devise aggressive strategies to tackle the situation, enable recoveries and prevent similar situations in the future.

Babu Sivaprakasam is a partner, Deep Roy is an associate partner and Sharmila Ratnam is an associate at Economic Laws Practice. This article is intended for informational purposes and does not constitute a legal opinion or advice.

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