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De-jargoned: Recapitalization

LiveMint logoLiveMint 15-05-2014 Rajesh Kumar

Reserve Bank of India (RBI) set up the Expert Committee to Review Governance of Boards of Banks in India on 20 January 2014 under P.J. Nayak, former chairman and chief executive officer of Axis Bank Ltd. The Committee report was released on 13 May, in which it recommended, among other things, that either public sector banks be privatized or new governance structure be designed so that these banks can compete in the marketplace and are not dependent on the government for capital support. The committee noted, “Given the lower productivity, steep erosion in asset quality and demonstrated uncompetitiveness of public sector banks over varying time periods (as evidenced by inferior financial parameters, accelerating stressed assets and declining market share), the recapitalization of these banks will impose significant fiscal costs.”

What is recapitalization?

It basically means a change in the capital structure of a company. For example, if a company has significantly high amount of debt on its books, it can raise equity capital to bring down the debt-equity ratio to comfortable levels. In the present context of public sector banks (PSBs), it also refers to raising equity capital. PSBs dominate the banking business in India. Since asset quality has worsened in the recent times, banks will have to raise capital to be able to expand their balance sheet to meet the funding demand of a growing economy and also to meet regulatory requirements.

Since the government of India is the majority shareholder in these banks and unwilling to reduce its stake, it will have to contribute heavily in terms of equity capital and the money will have to come from the budgetary resources. In the interim budget presented in February 2014, the government made an allocation of `11,200 crore for recapitalization of PSBs. However, a few days later, Moody’s Investors Services, a global rating agency, said that this amount was inadequate and PSBs, according to the agency’s estimates, would need `25,000-36,000 crore by end of March 2015 (see

The debate

PSBs are in need of capital but the problem is that the government is running a high level of deficit and is short of resources to be able to infuse additional capital into banks. Such capital infusion would, therefore, put even more pressure on budgetary resources and would leave lesser with the government to invest in capacity building or to spend on social sector. However, if the recapitalization is delayed for too long, it will affect the ability of banks to lend to the productive sectors of the economy, which can affect growth prospects in the medium to long term.

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