Recapitalization of Public Sector Banks (PSBs)

Recapitalization and Its Importance:

• Recapitalization is the process of infusing fresh capital into banks to enhance their capital base and meet regulatory requirements, such as Basel III norms.
• Public Sector Banks (PSBs) in India have faced the need for recapitalization due to the impact of increasing Non-Performing Assets (NPAs) and the requirement to conform to Capital Adequacy Ratio (CAR) norms.

Government Initiatives:

1. Indradhanush (2015): The government committed to recapitalization through the Indradhanush plan in 2015. This initiative aimed to strengthen the capital base of PSBs and improve their overall health.
2. Recapitalization Bonds (2017): In 2017, the Government of India (GOI) floated recap bonds, which were subscribed to by PSBs. The funds raised through these bonds were used by the GOI to purchase shares of select PSBs.

Mechanism of Recapitalization:

• Recapitalization involves changing the capital structure of banks, typically through the infusion of fresh capital or the conversion of debt into shares and vice versa.
• The GOI issued recap bonds, which were purchased by PSBs. The funds raised through these bonds were then used to buy shares of PSBs.

Benefits of Recapitalization:

1. Compliance with CAR Norms: PSBs can use the equity capital obtained through recapitalization to meet Capital Adequacy Ratio (CAR) norms, allowing them to lend deposit money.
2. Improved Health and Lending Capacity: Higher capital enables banks to strengthen their financial position, enhance their lending capacity, and potentially improve profitability.
3. Win-Win Solution: Recapitalization through bonds benefits both the government and banks. Banks receive interest on the bonds, and their share prices rise, while the government can sell shares at a higher price to redeem the bonds.

Advantages of Recap Bonds:

• Avoiding Taxation: Raising funds through recap bonds helps the government avoid taxing citizens directly for capital infusion into banks.
• Avoiding Market Crowding: By borrowing directly from the banking system instead of the markets, the government can avoid crowding out private borrowings.

Downsides and Considerations:

1. Moral Hazard: There is a concern that banks might engage in reckless lending if they expect the government to rescue them, leading to a moral hazard.
2. Fiscal Deficit Impact: The calculation of fiscal deficit is a crucial consideration in recapitalization policies.

Long-Term Impact and Governance:

• To ensure lasting benefits, it is emphasized that temporary relief through recapitalization should be coupled with improvements in PSB governance based on recommendations from committees such as the PJ Nayak Committee and the Banks Board Bureau (BBB).

Conclusion: Recapitalization plays a vital role in strengthening the financial position of PSBs and supporting their lending activities. While it provides temporary relief, addressing governance issues is crucial for sustained improvements in the performance of public sector banks.