Recapitalization Of Banks - Indian Economy
INTRODUCTION
In order to bring state-owned banks up to capital adequacy rules, recapitalization of banks involves putting more capital into them. Using a number of tools, the government provides capital injections to banks that are low on funds. All commercial banks must adhere to specific Basel-based capital adequacy standards set by the Reserve Bank of India (RBI).
Let's look at the definition of recapitalization, the benefits of recapitalization, recapitalization in India, and the negatives of recapitalization in this article.
WHAT IS BANK RECAPITALIZATION?
• For state-owned banks to meet capital adequacy standards, more capital must be injected into them.
• The Reserve Bank of India has emphasized that Indian public sector banks must maintain a Capital Adequacy Ratio (CAR) of 12% in accordance with BASEL standards.
• The ratio of a bank's capital to its risk-weighted assets and current liabilities is known as the capital-to-risk-weighted-assets-and-current-liabilities ratio (CAR).
• Using a number of tools, the government provides capital injections to banks that are low on funds.
• It is the government's duty to increase capital reserves because it holds the greatest share in public sector banks.
• Banks receive capital injections from the government in the form of bonds or fresh stock purchases.
• The government had announced a recapitalization package for public sector banks around Rs. 2.11 lakh crore in 2017.
WHY IS RECAPITALIZATION NECESSARY?
• In compliance with RBI regulations, the government, which is also the largest shareholder, injects capital into banks by either purchasing additional shares or issuing bonds.
• The government periodically announced recapitalizations to keep the state-run banks afloat as they battled mounting nonperforming assets (NPAs).
• State-run banks hold 70% of the total market share in the Indian banking sector when it comes to asset size.
• Recapitalization of the banks is "essential" for the nation's economic recovery.
• In order to help banks comply with Basel III's stricter regulatory capital requirements.
• Gross non-performing assets (NPAs) for PSBs climbed from 4.72% in March 2014 to 12.47% in March 2017.
INDIA'S RECAPITALIZATION
Recapitalization is accomplished in India in three main ways:
• Financial Allocation
• Market-based loans
• Bonds for recapitalization are issued.
Financial Allocation
• For bank recapitalization, the budgets for 2021 and 2020 each included Rs. 20,000 crores and Rs. 7000 crores, respectively.
Market-based loans
• In order to recapitalize banks, the government announced in 2017 that banks would raise Rs. 10312 crores from the market in the form of shares and bonds.
Bonds for capitalization
• Bonds that the government issues are bought by banks. As the government increases its share of equity ownership, the funds it has amassed are utilized to bolster banks' equity capital reserves.
• Recapitalization bonds are categorized as an investment that pays interest because they were purchased with bank money. Because no money is withdrawn directly from the government's coffers, it is able to maintain its budget deficit target.
• Recapitalization bonds for banks were issued in a series between January 2018 and March 2020.
BONDS WITH A UNIQUE ZERO COUPON FOR RECAPITALIZATION:
• These are particular bonds that the federal government has issued to a particular institution.
• Nobody else may invest in them; only the designated banks may do so.
• It cannot be traded or transferred. It can only be used at one bank, and it expires quickly.
• It is a zero-coupon, issued at par, and will be paid at the end of the term; there is no coupon.
• A coupon is the name for the interest that a bondholder receives.
• It is held in accordance with the bank's Held-To-Maturity (HTM) category.
• The purpose of buying HTM securities is to keep them until they mature.
• These instruments, which are issued in compliance with RBI regulations, are comparable to recapitalization bonds but have the same purpose.
• The issuance of these special bonds will give the bank much-needed equity capital while having no effect on the fiscal deficit.
• For instance, Rs. 5,500 crore worth of Special Zero-Coupon Recapitalization Bonds would be issued in order to recapitalize Punjab & Sind Bank.
BENEFITS OF CAPITALIZATION
• In addition to increasing tax revenue and partially reducing the budget deficit, it will also enhance lending and, as a result, economic growth.
• The capital injection in PSBs will cut loan rates, increase aggregate demand, activate dormant industries, and encourage investment within two to three years.
• The government can eventually transform these recap bonds into ordinary G-secs and sell them on the open market when the economy grows.
• Banks will find it simpler to raise equity capital as a result.
• The downward pressure on Viability Ratings (VRs) has increased over the past three to four years and will be lessened by a capital infusion.
• By doing so, banks will be better able to manage their financial risk and adhere to Basel-III regulatory capital requirements.
• It also serves as a safeguard against a projected rise in provisioning for non-performing assets (NPAs).
NEGATIVE EFFECTS OF RECAPITALIZATION
• Fiscal Deficit: Recapitalization will be difficult because of the government's requirement to adhere to severe budgetary deficit goals.
• Recapitalization will not lead to the redemption of bad debts, hence it is not the answer for bad loans.
• Moral Hazard: Banks may not take the required precautions when lending since they know the government will step in to help if the loans default.
• Interest Payments: Over the course of five fiscal years (beginning in FY21), the Centre may wind up paying approximately 1.2 lakh crore in interest on recap bonds.
CONCLUSION
Recapitalization cannot be the only answer to the problem of the banks' bad books. The financial reforms must be properly planned out and put into action as soon as possible. In order to improve the effectiveness of public sector banks while minimizing the dangers associated with supporting private actors in the banking industry, the government should pursue a certain strategy.