How govt can play PSU bank stocks

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India’s state-run banks are grappling with the twin challenges of bad loans and the requirement of massive capital. The combination of bad and restructured loans is around 12% of the assets of public sector banks. The Reserve Bank of India (RBI) is well aware of the problems that have been plaguing these banks, accounting for roughly 70% of the industry. It has been aggressively taking steps to sensitize them on the importance of recovery as well as early detection and strict monitoring of stressed assets. Around Rs.10 trillion worth of infrastructure projects have not been able to take off in the absence of various clearances. With a stable government at the Centre determined to push stalled projects and the reform agenda, one expects Asia’s third-largest economy to be in a better shape by the end of the fiscal year. If indeed that happens, the quality of banking assets will improve.

However, there is no easy solution to the capital problem of state-run lenders. According to RBI’s internal estimate, public sector banks will need around Rs.8 trillion of capital in next five years—till March 2019—if their annual credit growth is 20%. The need for capital will drop to around Rs.5 trillion if the credit growth is around 15%. In the past one year, till end of May, credit growth has been 13% compared with 13.9% in the previous year. Between 2006 and 2008, when the Indian economy grew at more than 9%, the annual credit growth had been between 22% and 31%. For two successive years, the Indian economy has grown at less than 5%.

The banks will need capital to support loan demand from corporations after buying government bonds, the volume of which has been rising in the past few years because of the high fiscal deficit. Besides, the new international norms, following the third Basel accord, will also kick in after five years, in March 2019. Developed in response to the deficiencies in financial regulations exposed by the 2008 global financial crisis, the new norms are expected to strengthen banks’ capital requirement by increasing liquidity and decreasing bank leverage.

Recently, financial services secretary G.S. Sandhu ruled out further fund allocation in the forthcoming Budget to recapitalize state-owned banks. The interim Budget of February, presented by former finance minister P. Chidambaram, had earmarked Rs.11,200 crore for this purpose. Last year, the Budget had provided for Rs.14,000 crore for public sector banks’ recapitalization. Sandhu also said the government is likely to take a decision on a proposal to create a holding company structure for public sector banks before the Budget and a road map for this is likely to be announced in the budget. An RBI panel, headed by P.J. Nayak, former chairman of Axis Bank Ltd and former chief executive officer of Morgan Stanley India, has suggested lowering of the government stake in public sector banks to 51% to meet their capital requirement and setting up a holding company for them. If the government decides to transfer its stake in public sector banks to a holding company, the banks will be free from the shackles of investigating agencies like the Central Bureau of Investigation and the Central Vigilance Commission and this will have a positive impact on their decision-making process.

The government is not willing to bring down its stake below 51%, allowing privatization of the state-run banks. In an earlier column, I had suggested that if the government doesn’t want to lose its hold, it can retain its majority stake in the top six public sector banks and recapitalize them using the money generated by selling stakes in smaller state-run banks. It can bring down its stake in relatively smaller banks to 26% and continue to have the power to block any special resolution. Another way of approaching the capital problem could be selling stakes in those banks where the government holding is relatively larger and use the money to prop up its stakes in a few large banks which have been doing well on the bourses. At an appropriate time, the government can sell stakes in the large banks and make money. The entire exercise will be cash-neutral—as the government will pump in capital into large banks using the money generated out of sale of its stake in other banks—and it will not have to bring down its stake below 51%.

Currently, the government’s stake in public sector banks varies between 88.63% (Central Bank of India) and 56.26% (Bank of Baroda). In 12 banks, the government holds at least 70% stake while its stake is less than 60% in six banks. Since January, the Bankex, BSE’s banking index, has risen close to 35% and the gain in individual bank stocks varies between 78% (Union Bank of India) and 22.6% (Bank of India). At least 11 public sector bank stocks, including that of State Bank of India, have risen more than 50%.

The analyst community feels they will rise further with faster economic expansion and improvement in the quality of assets. Based on price-to-book ratio, a popular valuation metric for banks, almost all public sector lenders are undervalued. Barring State Bank of India, not a single public sector bank has more than a price-to-book ratio of one, while among private banks, Kotak Mahindra Bank Ltd’s stock trades at a price-to-book ratio of more than 5, HDFC Bank Ltd close to 3 and four others—Axis Bank Ltd, ICICI Bank Ltd, IndusInd Bank Ltd and Yes Bank Ltd—more than 2.

The government can pare its stake in Central Bank, United Bank of India, Bank of Maharashtra, Indian Bank and a few others where it holds more than 70% stake and use the money to raise its stake in Punjab National Bank, State Bank of India and Bank of Baroda. At a later stage, it can sell stake in these banks and make hefty profits.

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