Rescue plan for state-run banks

Rescue plan for state-run banks
The Indian government issued a statement that said a US$32 billion bailout package for major state-run banks will not happen again. Lenders are expected to find their..

The Indian government issued a statement that said a US$32 billion bailout package for major state-run banks will not happen again. Lenders are expected to find their own funding by selling non-core assets and merging with one another.

Background

The modern banking system in India originated at the end of the 18th century. Some of the initial banks were the Bank of Hindustan, established in 1770 and liquidated in 1829–32, and the General Bank of India, established in 1786 but closed in 1791.

The State Bank of India (SBI) is the largest and the oldest still in existence. It was one of three banks funded by a presidency government along with Bank of Bombay in 1840 and Bank of Madras in 1843. In 1921, these three banks merged forming the Imperial Bank of India, which in 1955, after India's independence, became the State Bank of India. For several years, the presidency banks were the quasi-central banks, until the establishment of the Reserve Bank of India in 1935, under the Reserve Bank of India Act, 1934.

The Indian banking sector is categorized into scheduled and non-scheduled banks. Scheduled banks are further classified into: Public Sector Banks; State Bank of India and its associates; Regional Rural Banks (RRBs); foreign banks; and other Indian private sector banks.

Public Sector Banks (PSBs) are banks with more than 50% stake held by the government. India has a total of 21 PSBs across the country. In 1955, with the nationalization of the Imperial Bank of India by the Central Government, a 60% stake was bought by the Reserve Bank of India to form the State Bank of India. In 1959, seven other state banks became the subsidiaries of SBI when the State Bank of India (Subsidiary Banks) Act, 1959 was passed under the Nehru government.

In July 1969, the next major government transformation in the Indian banking system took place when the Indira Gandhi government nationalized an additional 14 major banks. This increased the presence of nationalized banks in India, with 84% of the total branches coming under government control.

Analysis

India’s 21 public sector banks account for more than two-thirds of India’s banking assets. These banks also account for nearly 90% of sour loans in the banking sector. A sour loan refers to a non-performing loan on which interest is overdue and full collection of principal is uncertain.

In October 2017, the finance ministry announced a rescue plan for state-run banks worth 2.11 trillion rupees (US$32.41 billion) to assist banks set aside enough for their bad loans and boost credit growth in an economy like India’s where banks are the main source of funding.

A senior official who oversees the state banking sector stated that “We brought you out of the intensive care unit (ICU). Now, if you again go back to the ICU, and we keep bringing you out, that’s not how it’s done.”

According to the official, the Indian government is expected to get the total number of state-run banks to down to 12-13 from 21 now through mergers. However, no time frame was provided for the deal. Nevertheless, some bank mergers are likely to happen during the current financial year (2018-19).

Recently, the Reserve Bank of India introduced some changes in rules that altered existing loan-restructuring schemes and looks to turn more defaulting companies into the bankruptcy courts. This could mean that non-performing loans in state-run banks could rise from nearly 8 trillion rupees presently, although 10 trillion rupees would be the upper limit for any such hike.

To avoid the repetition of situations like Punjab National Bank’s US$2 billion fraud, the government is requesting banks to periodically monitor loans above 2.5 billion rupees and report to their board meetings every quarter. Additionally, the government is working to ease the country’s underdeveloped bankruptcy laws to help speed up the resolution process.

One of the proposals set forth emphasizes allowing a resolution process to go ahead if 66% of the creditors vote for it, as opposed to the current requirement of a minimum of 75%.

Assessment

Our assessment is that the plan by the central government to merge banks might precipitate the problem further. The merging Air India, a loss making enterprise, with Indian Airlines, a profit making public sector undertaking, is an example when the merger of two entities, one profitable, one loss-making take place. In this instance, the merged entity has also become highly unprofitable. We believe that it would now be more difficult for banks to access funds and streamline their operation. While trimming of assets could be an immediate solution, we feel that it is not going to help the core of banking in the long run. 

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