The COVID-19 pandemic has had a mixed impact on the banking sector with the finances reflecting robust profitability amidst lower provisions and higher treasury income while bank credit-offtake in the economy being subdued and looming threat of high NPAs in the near future.
The Financial Stability Report released by the RBI points that the banking system has faced the pandemic with relatively sound capital and liquidity buffers but nonetheless the pandemic threatens to result in balance sheet impairment and capital shortfalls.
Macro stress tests indicate the gross non-performing assets of the banking system to increase from 7.5% in September 2020 to 13.5% in September 2021 with the asset quality of public sector banks (PSBs) deteriorating to 16.2%. Capital adequacy is estimated to slip from 15.6% in September 2020 to 14% in September 2021.
Together, these are early warning signs for both the RBI and the Government with an immediate response from the latter likely to be in the form of recapitalization of public sector banks in the Budget. Since FY13 onwards, total recapitalization of public sector banks hasbeen nearly Rs 3.6 lakh crore, of which Rs 2.7 lakh crore has been via the recapitalization bonds. The latter started since FY18 onwards and is a reasonable accounting technique to keep the fiscal deficit in check.
The government had not budgeted for recapitalization during the previous budget but in September 2020 received a parliamentary nod of Rs 20,000 crore for recapitalization via bonds. The government could recapitalize PSBs through recap bonds in the range of Rs 35,000 – Rs 50,000 crore while the balance shortfall being met through internal accruals.
The Budget is unlikely to have any credit-specific measures after the Government and RBI have already announced a series of liquidity measures for SMEs (ECLGS 1.0), various sectors (ECLGS 2.0, TLTROs), farmers in order to maintain congenial financial conditions and preserve the solvency of businesses and households.
Additionally, there are four debatable recommendations: bank mergers, privatization of public sector banks, formation of a Banking Investment Company (BIC) and formation of a bad bank; which have a legacy during pre-Budget discussions, but all may not find its place again in the final Budget announcements.
With 4 public sector banks recently being merged, the government will analyze the synergies from the merger before planning more. Privatisation of banks could be a good option from the point of disinvestment proceeds and in the first economic stimulus package there has also been an announcement of an overarching framework for privatizing public sector enterprises. But with recent governance issues with certain private banks, the Government may think of alternatives.
One such alternative is the creation of the BIC, which was initially recommended in the PJ Nayak Committee in 2014 and this could translate into gradual disassociation of the government from the operations, management and governance of PSBs. This would be a welcome step for improving governance but the government will need to ensure necessary freedom to the BIC.
Lastly, the proposal of a bad bank could be deferred and concretized later after more deliberations with the RBI. An uncertain future looms ahead for the banking system and therefore we can expect long-term blueprints rather than just short term fixes.
Sushant Hede is an Associate Economist with CARE Ratings Limited. Views expressed are personal