Not Two, `Three’​ Cheers For Banking

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Every economist and banking analyst has got their fiscal deficit estimate for FY 2021 and 2022 wrong but, smelling growth, none is complaining about an expansionary Budget. Equity market, led by the bank stocks, cheered it full throttle.

At the macro level, the rise in the bank stocks signals investors’ outlook on Indian economy. More than this, three key elements in the Budget have excited them.

The first is privatization of two public sector banks. After 51 years of bank nationalization, the government has finally admitted that it should not be in the business of running all PSU banks. While Rs20,000 crore recapitalization has been announced for such banks, two of them (and a general insurance company) will be privatized.

In February 2000, Yashwant Sinha’s Budget promised to reduce the government shareholding in PSU banks to 33 per cent without changing the public sector character of such banks but it never happened. Nirmala Sitharaman’s Budget has many steps ahead. Two banks will be “privatized” (beside IDBI Bank).

The banks are not identified. Will they be relatively bigger ones like Bank of India or Central Bank or smaller one such as Bank of Maharashtra or Indian Overseas Bank? Six such banks, big and small, have been left alone – outside the recent consolidation drive.

The second move is creation of a development finance institution (DFI) for infrastructure financing with a Rs20,000 crore capital. The “ambition” is to lend Rs5 trillion in next three years.

A DFI can play the role of a catalyst and lend long term. One of the key reasons for the pile-up of bank bad loans is the abolition of the DFIs in the late 1990s. Used to lending working capital, Indian banks have never felt comfortable for project financing. Besides, the bond market has not developed well enough to support infrastructure financing.

But the question is: Where will the fund come from? The DFIs had to die in the late 1990s after their source of cheap money dried up, forcing them to run huge asset-liability mismatches. Let’s wait for the structure of the DFI : Will it have an assurance model (for credit enhancement)?

Another point to ponder is that the previous two attempts to set up DFIs for infrastructure financing miserably failed as their management had no accountability. The Infrastructure Leasing and Financial Services Ltd boss got into a mess of misgovernance with its illustrious board looking the other way and Infrastructure Development Finance Company – born out of the July 1996 Budget – had to be converted into a bank as it could not survive in its original avatar. Sitharaman’s Budget has promised a “professionally-managed” DFI.

Finally, there will be a bad bank. While we await the fineprint, the Budget says an asset reconstruction company and an asset management company will be set up to consolidate and take over the existing bad loans of the banks, manage them and sell them to alternate investment funds and other investors. By RBI’s estimate, the non-performing assets of the banking sector could almost double to 14.8 per cent of advances by September 2021 from 7.5 per cent in September 2020.

While a DFI will help banks derisk their loan portfolios, creation of a bad bank will clean up their balance sheets. Since most of them have made hefty provisions against bad loans, the banks will make money which will add to their profits. Balance sheet strength will encourage them to lend.

The government will have to borrow more than what economists and banking analysts expected to bridge a higher fiscal deficit. Apart from capital investment, some of the off-balance sheet expenditure, including food subsidy, have got into the Budget, leading to the higher deficit figure.

Managing the government borrowing is Reserve Bank of India governor Shaktikanta Das’s headache. The benchmark 10-year bond yield breached the 6 per cent mark and rose about 15 basis points. Let’s wait for February 5 monetary policy to know how RBI plans to manage this.

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