MUMBAI -- While pledging 880 billion rupees ($13.86 billion) in aid to state-owned banks on Wednesday, India's Finance Ministry also handed out a set of guidelines that it wants lenders to conform to that will help clean up the financial system.
The ministry said that it wants lenders to work on improving customer responsiveness, responsible banking, deepening financial inclusion and digitalization, and staff development. At the heart of all this would be a drive to weed out corruption and improve efficiency.
Indeed, public-sector banks in India are in a bad way. Bad loans in the sector have piled up to around 7.34 trillion rupees as of the September quarter. Many of the banks that are receiving huge capital infusion this round are exposed to companies in bankruptcy proceedings.
IDBI Bank, which will receive 106.1 billion rupees in aid, has a nonperforming loan ratio of 16.1% as of September. It has exposures in companies such as Bhushan Power & Steel which has defaulted on loans worth 372.48 billion rupees, and Lanco Infratech, against which it has initiated insolvency proceedings.
Largest lender State Bank of India, which will get 88 billion rupees, is another bank whose defaulters include big corporations such as Essar Steel and Bhushan Steel.
State-run banks form the backbone of the economy, but decades of slipshod lending and a lack of innovation have led to continual losses. The Reserve Bank of India's strict instructions on accounting for bad loans in 2015 sent skeletons tumbling out of closets. Banks had until March 2017 to clean up their books to be eligible for capital infusions. They would also have to comply with global capital adequacy ratios.
The finance ministry said Wednesday that it will monitor strictly banks' lending practices and public accountability as part of its reform agenda."We are setting up an institutional mechanism to ensure what has happened in the past is not repeated. It is the government's responsibility to keep state-run banks in good health and ensure they follow the highest standards of corporate governance," said Finance Minister Arun Jaitley.
In terms of lending practices, the government said that banks should have no more than 10% exposure to big consortium loans. Loans of over 2.50 billion rupees will come under the purview of special agencies.
According to estimates by ICRA Research, the recapitalization exercise would cover 36% of IDBI Bank's net NPL, while for State Bank of India it would be around 9%. For UCO Bank, the net NPA coverage provided by the recapitalization would be as high as 59%.
The government has bailed banks out in the past, but opposition to using taxpayer money for this purpose has been growing louder. It is only recently that the government has decided to recapitalize banks through bond issuances, and is exploring the capital market, rather than paying directly from its budget.
This tranche, which is part of the broader 2.11 trillion rupee bank recapitalization plan, will be funded by bonds with tenors of 10-15 years and will be issued once the banks' boards have committed to the banking reforms. Another 81.39 billion rupees will be provided through budgetary support to these 20 banks. Banks have already raised over 100 billion rupees from the capital market and are likely to raise more in the coming months.
"Governance reforms for state banks have been lethargic, notwithstanding the frequency of talks around changes in governance and underwriting practices at state banks," analysts at Fitch Ratings said. "The current recapitalization exercise does offer an opportunity for the authorities to make a positive impact".