Divesting in RBI to recapitalize banks

• The Economic Survey 2015-16 put forth the argument that the Government of India could reduce its capital in the RBI from its current large level and use it to increase its capital in public sector banks, which face a capital shortage.
• Public sector banks (PSBs) in India have faced major losses due to the need to write off large non-performing assets (NPAs). Accordingly, their equity capital has been reduced substantially. There is a need to recapitalise these banks, given the Basel capital adequacy norms. Also, given the policy of the Government of India (GOI) to maintain the public-sector character of these banks, it is imperative that only the GOI recapitalises these banks

Analysis

• There is no doubt the recapitalization of PSBs who are struggling with the NPAs is the need of the hour. This recapitalization can be financed in 3 ways: i) Increasing the govt. Revenues ; ii) Increasing the govt. Borrowings. iii) Divesting in some assets and using the money to recapitalize PSBs.
• The third options seems to be a better and more practical approach than the other two. Economic Survey also advises to do the same. RBI is owned by the Govt. of India and its equity capital is much higher compared to international standards. RBI is an outlier with an equity share of about 32% of its balance sheet size, second only to Norway and well above that of the US Federal Reserve and the Bank of England whose ratios are less than 2%. The conservative European Central Bank and emerging market central banks have much higher ratios, but even they do not approach the level of the RBI. Equity includes the capital, retained earnings and contingency funds.
• If RBI were to move even to the median of the sample (16%), this would free up substantial amount of capital to be deployed for recapitalizing the PSBs
• Government can thus, afford to reduce its equity in RBI and use the resources generated to recapitalise PSBs.
• However there is possibility that this cannot be a good move. Let us assume that RBI buys back some of its shares from the govt. by giving up its government Bonds (say to the tune of 2 trillion). Now government will have to sell these bond in the open market to households so that it can raise finance for recapitalization of PSBs.
• However, the assumption that households will buy such bonds to the tune of 2 trillion is unrealistic. Households do not have such big capacities , that is why in the first place such RBIs and PSBs are expected to hold govt bonds. So in a nut shell by this move, finances cannot be raised and PSBs cannot be recapitalised.
• Avoiding disinvestment worth trillions in RBI and going for much practical disinvestment may actually work in generating finances for recapitalisation of PSBs.
• Also, this seems a non-transparent way of proceeding, getting the banking regulator once again into the business of owning banks, with attendant conflicts of interest

By: Vishal