Given the current economic downturn and the mounting NPAs, the current Indradhanush plan seems to be insufficient.
Formulating a more comprehensive plan for reforming the PSU banks becomes inevitable.
What is the proposed new reform?
RBI's deputy governor has suggested a ‘Sudarshan Chakra’ solution for PSU banks, in the place of the earlier 'Indradhanush' plan.
It envisages a comprehensive plan which is more focussed and targeted than the 'Indradhanush' plan.
It considers four “R”s which are envisioned as key to solving the problems of the banks.
They are:
Recognition.
Resolution.
Recapitalization.
Reform.
What are the features?
Recognition - The RBI’s asset quality review has made a considerable progress in this regard.
It has revealed the numbers on gross non-performing asset (NPA) in general apart from those in the PSU alone to be 12%.
However, this does not show the true picture as it does not include assets that are “stressed” but not yet NPAs.
The market assessment is that when these stressed assets take the form of NPAs, the NPA percentage may increase by up to 6%.
Thus, identifying the right proportion of the stressed assets is the first step to resolving them.
Resolution - The Insolvency and Bankruptcy Code (IBC) is a major reform in appropriately addressing the bad loans problem.
The process under IBC will certainly clean up the books of the banks over the coming months.
Nevertheless, the challenge is to find new investors who are willing to take over defaulted projects.
The banks will have to face huge losses so as to attract new investors and this is sure to have an impact with a corresponding erosion of capital.
Recapitalization - In 2015, the finance ministry had estimated that the PSU banks needed Rs.2.4 trillion of capital from market, retained profits and the budget.
The Fitch Ratings estimate the need to be Rs.4 trillion by end of March 2019, to meet the capital requirements under Basel III.
The finance ministry is thus under huge challenge given the mounting NPAs along with pressures for fiscal stimulus to counter the current slowdown.
Keeping on stimulating the economy through increased government expenditure and draining out public funds is not a sound fiscal measure.
Perhaps, weak banks that have eroded their capital substantially could be subjected to RBI’s “prompt corrective action” discipline.
This can limit new commercial lending until their capital position improves.
On the other hand, the healthier banks and non-bank financial companies, both private and public, can expand and occupy the lending space created.
Reforms - 1) Reforms in PSU banks are essential to make them more efficient, and this is needed irrespective of whether or not to recapitalize them.
Merging public sector banks cannot be considered a reform to address the problems at present.
Instead, there is a need for reforms that improve governance, upgrade the skill set, and improve the quality of risk assessment within the PSU banks.
2) Government should think of reducing its equityto 33% in selected PSU banks, as recommended by Narasimham II Committee in 1998.
The government could still have a controlling position in the board, but the banks could become board-managed companies.
This would allow the stronger PSU banks to raise additional capital from the market, possibly from strategic investors who are offered seats on the board.
Inclusion of strategic investor may make it easier to raise capital without burdening the budget.
In all, the scale of the bad loans problem is much larger than was thought and the downturn in the economy necessitates more urgent corrective measures.