<p><em>Indian state-run banks need aggressive capital infusion, writes <strong>Anil Agarwal</strong></em><br><br>Indian state-run banks need capital, a lot of it. I calculate they will need about $40 billion of capital by FY2019 to meet Basel III requirements and grow balance sheets at around 10 per cent a year.Decision makers clearly understand the need to capitalise the banks. But they are not showing any alacrity in funding these banks — probably driven by the view that full implementation of Basel III is four years away.<br><br>They expect banks to raise equity from markets, but for most of these banks, investors are reluctant to put in new capital unless the government invests adequate capital and removes tail risks.<br><br>My view is that the Indian state-run banks need to be capitalised soon — at least to a level that allows them to start growing their balance sheets by double-digit annual percentages again. State-run banks are currently growing at around 7 per cent, which creates a number of problems:<br><br><strong><img alt="" src="http://bw-image.s3.amazonaws.com/Anil-Agarwal-mdm.jpg" style="width: 200px; height: 200px; float: right; margin: 3px;">1.</strong> The state-run banks account for 70 per cent of system loans, and if they don’t grow their loan books in double-digit terms, it will be very tough for system loan growth to go above 11-12 per cent, thereby dragging economic growth. Moreover, private banks are likely to be very reluctant to fund long-term projects, given the<br>risks. They are likely to concentrate on consumer, SME, and working capital loans. Hence, private capital expenditure cannot increase sustainably without state-run banks being able to lend.<br><br><strong>2.</strong> The bulk of the state-run banks’ reported loan growth is going towards interest capitalisation on existing corporate loans. This implies that net new loan disbursals for these banks are close to zero. This effective deleveraging is causing an already bad loan book to get worse.<br><br><strong>3. </strong>With credit costs remaining high, the state-run banks have to keep loan yields high to make enough margin, so they can report some profits. This lack of competition is helping banks keep lending rates high (reflected in all-time high RoAs at private banks), thereby hindering transmission of any rate easing.<br><br>The longer the decision on capital infusion is delayed, the greater the cost will be. As banks de-leverage, the existing balance sheets will likely get worse — ultimately implying a higher cost to clean up balance sheets. Moreover, the inability of almost 70 per cent of the system to grow can hinder economic growth materially.<br><br>So what is needed? The current strategy of ‘extend and pretend’ is clearly not working. The longer a solution is delayed, the more costly it will be.<br><br>The problem is solvable. Indian state-run banks need aggressive capital infusion, a la TARP in the US, where balance sheets were quickly cleaned up, write-offs taken, and banks recapitalised. I believe a government infusion of $14-15 billion in state-run banks (1 per cent of GDP) is needed relatively quickly. This would help them clean up their balance sheets and start growing again in the right areas. As tail risk declines, investors will likely come in and provide the bulk of the remaining funding — such an infusion could actually turn into a good investment for the government, in addition to funding the growth agenda. <br><br><em>The author is head of AxJ Banks Research, Morgan Stanley</em><br><br>(This story was published in BW | Businessworld Issue Dated 10-08-2015)</p>
