Capital Infusion in Public Sector Banks (PSB): Effect on Mutual Funds

28 March 2023
5 min read
Capital Infusion in Public Sector Banks (PSB): Effect on Mutual Funds
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The central government invested Rs 3.31 lakh crore in public sector banks between FY17 and FY21 but has yet to do so since due to the institutions' steadily improving financial condition.

Is there a need to recapitalize banks again in the face of rising inflation, global recessionary winds, shaky stock markets, and several rate hikes?

As of December 31, 2022, all PSBs have more than a 100 basis point cushion above the regulatory Tier I capital requirement. It is 10.8% for SBI, 12.6% for Bank of Baroda, 13.7% for Canara Bank, 11.6% for UCO Bank, 12.3% for Union Bank, and 13.5% for Bank of Maharashtra, and 13.6 per cent for Bank of India.

During the third quarter ending December 2022, public sector banks (PSBs) reported a healthy profit rise of 65% to Rs 29,175 crore, with Bank of Maharashtra (BoM) emerging as the top performer in terms of profit percentage growth.

Banks remain confident in their capacity to self-fund their capital needs, with Bank of Baroda expecting to complete the year with a capital adequacy ratio above 16% and no need to tap markets or seek more capital from the government.

History of Capital Infusion in Indian Banks

Recapitalization of banks, i.e., capital infusion into the banks, started in India in the 1990s when the Indian economy was on a downward growth trajectory. However, because of the trade-off between the fiscal deficit and the extent of capital infusion, there has been a limit to how much the Centre can infuse from the state coffers. 

According to media reports, this method invested as much as INR 20,000 crore into PSBs in the 1990s. In 1993-95, the then UPA government introduced recapitalization bonds to help distressed Indian banks.

Recapitalization bonds are less disruptive for government finances though the bond market is expected to be the biggest casualty irrespective of the route chosen to issue them.

It is a bond issued for the recapitalization of banks. Whenever the banks require liquidity, the government will issue recapitalization bonds. Banks will lend money to the government by subscribing to the bonds and entering it as an investment in their accounting books.

Money raised by the government through recapitalization bonds will go back to the bank as capital, strengthening the banks' balance sheet and showing strong capital adequacy.

In 2015, the newly elected Modi government at the Centre announced a capital infusion of INR 70000 crore in PSBs under the "Mission Indradhanush" umbrella scheme over 4 years.

The plan proposes an injection of around INR 25,000 crore in 2015-17, followed by around INR 10,000 crore in subsequent years till FY-2019.

Need of Recapitalization of PSB

  • To Improve the Capital Adequacy Ratio

The capital adequacy ratio is a measure of a bank's capital. The recapitalization plan will provide the capital to the banks to meet the capital adequacy ratio under Basel III norms.

Basel Norms are the set of international banking regulations put forth by the Basel Committee on Bank Supervision, which set out the minimum capital requirements of financial institutions to minimize credit risk. Currently, all banks across the globe follow Basel III norms. 

  • To Tackle the Problem of NPA

The Indian banking system is piled up with many bad loans, also known as stressed assets. These stressed assets for Indian banks are close to INR 10 lakh crore now, which is more than the GDP of nearly 140 countries and is only growing.

A loan becomes an NPA when borrowers have stopped repaying the principal amount or the interest on them and have slim chances of recovery. 

The capital infusion by the Centre now comes after the Indian Bankruptcy Code has imposed valuable deadlines on banks, forcing them to take haircuts and revive assets, if necessary, with new promoters. Re-capitalisation of PSBs is very important, considering their overwhelming industry domination.

The capital infusion should strengthen PSBs to reform their processes, take vigorous action to resolve NPAs, and resume lending. The latter is vital for the sluggish Indian economy.

  • To Revive the Sluggish Indian Economy

Move like demonetization to scrap a majority of currency in circulation and the rollout of a wide-ranging tax reform like GST disrupted the growth momentum of the Indian economy.

Other factors like low private investment and sluggish exports are also responsible for this slowdown and losing its title of the fastest-growing economy in China.

The additional capital infusion is vital for the recovery of the sluggish economy. It will increase lending, which will spur growth numbers. Therefore growing tax collections, creating employment across various sectors, and partly bringing down the fiscal deficit.

The Government has taken a well-integrated initiative to sustain domestic demand and growth while creating work.

Impact of Capital Infusion on Mutual Funds

Recently, many mutual funds houses have abandoned the banking sector companies, especially the PSBs, due to the problem of severe lousy loan issues. So also, this fund category has been declining for a while.

But after Also capitalization news, fund managers of big fund houses believe that investing in a sector fund is a good bet to have exposure to the banking sector.

So this is the right time for investors to look into the banking sector, as Indian banks form a significant part of the stock market and are an essential part of mutual fund portfolios.

Looking at the Indian debt market, there will be no significant impact of this new move by the government. However, the bond yield decreased slightly from 6.80% to 6.79% after the announcement of capital infusion to PSBs. 

In the long run, infusion aims to strengthen the lending capacity, expected to mitigate losses and improve credit growth among PSBs, eventually lowering bank lending rates and increasing bond yield.

Both equity and debt markets are currently welcoming this move as it is a well thought move to fast-track the revival of the sluggish Indian economy.

Happy investing!

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