Q4 Bleeds Banks: Indira Gandhi’s Bank Nationalisation Folly Bites Taxpayers

Raghuram Rajan’s “deep surgery” to fix the bad loans problem in Indian banking has led to another bout of enormous blood-letting in the fourth quarter of 2015-16.

The wages of Indira Gandhi’s bank nationalisation sins are finally coming home to roost. They will bite the taxpayer in the butt, for loss-making banks have to be recapitalized with taxpayer money.

Just seven nationalised banks have reported results so far, but the collective net losses reported by them in the January-March quarter dwarf the losses reported in the previous quarter by a wide margin. Q4 performance makes Q3 performance look like rude good health.

In the October-December quarter, public sector banks collectively reported losses of Rs 12,869 crore; in the fourth quarter ended March 2016, blood is gushing from every wound on the balance-sheet. Seven banks have posted a collective loss of over Rs 14,275 crore, surpassing the Q3 figures by a wide margin. And there could be more carnage to come, as many big banks are still to report their final figures.

One cannot rule out a collective public sector loss touching Rs 25,000 crore – almost the amount of capital the government promised to inject this year.

The losses so far: Punjab National Bank (Rs 5,367 crore), Bank of Baroda (Rs 3,230 crore), Syndicate Bank (Rs 2,158 crore), Uco Bank (Rs 1,715 crore), Central Bank (Rs 898 crore), Allahabad Bank (Rs 581 crore), and Dena Bank (Rs 326 crore).

PNB’s losses are the worst in Indian banking industry.

Yet to come are State Bank of India, Canara Bank, IDBI Bank and Bank of India among major banks, and a host of mid-sized to smaller banks. The bad news will come all through May.

The huge scale of losses has important implications for fiscal consolidation and the Indian economy.

First, banks may need even more capital than the Rs 25,000 crore provided in the last budget. This money will have to come from the budget rather than from the market, for the huge losses have depressed stock prices so much that you can buy entire banks for just Rs 2,000-3,500 crore (Dena, Oriental Bank, Allahabad Bank). Syndicate Bank’s fourth quarter losses are nearly 40 percent of its market capitalisation.

Second, given high levels of bad loans, banks’ ability to lend will be constrained for at least one more year, and that too only if additional capital is forthcoming. Achche din depends on banks being revived first before lending to industry revives.

Third, the entire public sector banking sector put together has a valuation approximately equal to one private sector bank – HDFC Bank. HDFC Bank’s valuation as on 18 May was around Rs 2,87,000 crore. Most mid-sized public sector banks are in the valuation range of Rs 2,000-5,000 crore – less than $1 billion. It is pointless to pretend that public sector banking is a good idea. It is actually destroying capital at an astonishing pace.

Are there out-of-the-box remedies for this situation? Yes.

#1: It makes sense for the government to actually raise its stake in nationalised banks – even 100 percent in some cases – in the short run. It can make a clean profit once these banks are fit and in good health and the stakes can be brought down again. A short-term bulge in the fiscal deficit due to this should not give any of the rating agencies apoplexy.

#2: The government should, as an interim measure, legislate a golden share for public sector banks, where 51 percent control can be retained by the government even as the economic benefits of expanded capital goes to private investors. But this can only be a short-term remedy. The only sensible long-term solution is privatisation, for it is unlikely that public sector banks, howsoever autonomous, can compete with private banks. The change in the Rajya Sabha power balance by the end of 2016 should enable the government to reverse the bank nationalisation acts. Banks were nationalised in two rounds, once in the late 1960s and again in the early 1980s, both times by Indira Gandhi.

#3: The unviable parts of the public sector banking industry should be restructured to focus on niches. With Raghuram Rajan opening up the sector for payment banks, small banks, wholesale banks and custodian banks, some of the smaller public sector banks can be turned into narrow banks, niche banks, or even bad banks, which can focus on buying bad loans and recovering whatever assets are recoverable. We could retain five mega-banks in the public sector, and convert the balance into focused niche banks or sell them off to private investors.

#4: The Reserve Bank should accelerate interest rate cuts to the best extent possible, for nothing can repair bank balance-sheets better than rate cuts that improve treasury profits from revalued bonds. A two percent rate cut over the next 12 months will do more for banks than a Rs 50,000 crore injection of capital.

This is the “deep surgery” that is needed following the huge blotches of red ink seen on balance-sheets in the fourth quarter of the last financial year.