Misuse of Good Money To Save Bad Banks AND to Save Bad Bankers--How Long FM Will Protect Banks Instead of Curing Real Cause of Sickness ?

Bank for the buck  ( From Indian Express )

BY:-----Ila Patnaik : Thu Jan 24 2013, 03:19 hrs

This year the government will put in Rs 12,500 crore for recapitalising public sector banks. Year after year, the ministry of finance puts more money into PSU banks. To expand banking in India, the government has chosen a two-pronged approach: putting more money into public sector banks while giving new licences for banking to private companies. In the present Indian system — with its lack of transparency, absence of the rule of law and pervasive corruption — a better policy to expand banking in India would be to divest public ownership of banks and convert them into widely held private banks.

Such a policy would address some of the RBI’s concerns about industrial houses owning banks, limit the use of taxpayer money to support inefficient banks and give the country a competitive banking system. India’s experience with public banks that have become widely held private banks, such as HDFC and ICICI, has been better than with new private banks, where family-dominated firms obtained licences.

Policy-makers in India like to claim that we have not had a banking crisis for a while. This claim is called into question when we witness the stream of money that has gone into PSU banks. Almost every year over the last two decades, the government has injected taxpayer resources into PSU financial firms. If we had done a recapitalisation of Rs 100,000 crore at one shot, it would have been obvious that there were big failures of financial regulation and policy. But when we dribble it out as Rs 10,000 crore per year for 10 years, it is not seen as rescuing a failing financial system.

PSU banks are not profitable enough to grow on their own steam. This reflects the failure of bureaucrats as bankers. Normally, profits are reckoned after paying for bad loans, and retained earnings are ploughed back into the equity capital of the bank. The equity capital with a bank determines how much of deposits it can take. A PSU bank that does not have equity capital will be forced to not take more deposits from the public. This constraint does not bind it as much as it should, as the RBI has often been lenient, tolerating the inadequacy of equity capital.

Indian banking has been rigged in favour of PSU banks in numerous ways. The RBI has blocked the entry of foreign banks and new private banks in an attempt to protect the cosy domination of PSU banks. A man who deposits money in a PSU bank knows it has the backing of the government. This is not the case with their competitors, and that helps increase the market share of PSU banks. Despite these violations of competition policy, PSU banks have failed to be adequately profitable. This makes them go back to the finance ministry for more equity capital.

At present, we have a finance ministry that is tightfisted when it comes to putting equity capital into PSUs owned by other ministries and discusses disinvestment of its holdings, but it is willing to put in additional capital when it comes to banks that are in its domain. The finance ministry needs to be as sceptical about putting equity capital into PSU banks as it is about putting equity capital into any PSU. If Air India does not get money, why should the SBI?

India is in a dire fiscal crisis and every single opportunity for cutting expenses should be harnessed. Even if there was money available for spending, it has better applications. In recent years when we have typically been lavishing Rs 10,000 crore every year into PSU financial firms, India would have done better if this same Rs 10,000 crore had been spent on building 2,000 kilometres of highways, or a metro system for a mid-size city like Nagpur.

A better option is to dilute government ownership in PSU banks and allow them to run and grow as normal private banks. In 1969, when banks were being nationalised, Indira Gandhi’s economic policy team thought it was wise for government to have 51 per cent ownership of PSU banks. We have reversed almost every element of Indira Gandhi’s economic policy framework, and this should be no exception.

We have two successful privatisations of PSU financial firms before us: HDFC and ICICI. Both were once controlled by the government and both are now dispersed shareholding companies. They were not sold off to some family, they became modern corporations. This roadmap — building dispersed shareholding private companies that are controlled by no family — should be followed for all PSU banks. This will require carrying legislation through Parliament, and it would make good use of the scarce political capital that the UPA possesses.

The government has made a case for giving out new licences for private banks. The RBI has rightly expressed concerns about banks run by industrial houses. In the past, Indian banking has suffered as the mechanism to prevent theft of depositor money by private banks lending to their business interest has been an issue. Banks must be dispersed shareholdings with professional managers — as is the case with ICICI or HDFC. In an ideal situation one would argue that the banking regulator should give licences to firms that it deems fit to run banks, but in today’s India, most people, and perhaps the regulator itself, is correctly concerned about the political pressure that may be brought to bear on the regulator if it opens up the gates to new private bank licencing. It would be wise to gather experience with enhanced supervision of lending to conglomerates before venturing to give bank licences to large industrial houses, who are often the ones with the money to apply for such licences. As the recent IMF financial stability assessment report also points out, in the current context, the risks of this policy may outweigh its benefits.

Another option to expand banking in India is to open up the sector to the entry of foreign banks. At present, India limits foreign banks, in all, to 18 bank branches per year. A much more open policy framework is required, through which foreign banks can build subsidiaries in India, who are then regulated by the banking regulator on the principle of ownership neutrality and given national treatment, including the lifting of all restrictions on opening branches.

The government should consider these policy options more carefully to give India a safer and more competitive banking system.

The writer, professor at the National Institute of Public Finance and Policy, Delhi, is consulting editor for ‘The Indian Express’, express@expressindia.com

http://www.indianexpress.com/news/bank-for-the-buck/1063781/0

24 JAN, 2013, 05.39AM IST, 

Stabilising Indian Banks through coercive rights

 Economic Times

By Yakov Amihud & T Sabri Oncu

Indian banks are reported to be experiencing an increase in non-performing assets (NPA) in their loan portfolios due to loans that went awry. This may considerably weaken banks' solvency. For example, NPA of 4% of assets, with recovery rate of 50% and capital ratio of 10%, means that the bank capital — including provisions — will decline by about 20%. While this is not a cause for alarm, it induces a repair of the banks' balance sheet. The best way to do it is by forcing banks with large NPA to issue coercive rights.

Banks should offer existing shareholders rights to buy additional shares at a discounted price. Suppose that a bank whose stock price is Rs 200 offers its shareholders one-for-one rights with an exercise price of Rs 100. After the rights are exercised, the share price will drop to Rs 150 because there are two shares that are claims on the former Rs 200, plus the newly-injected Rs100. Stockholders will be indifferent because their wealth has not changed. They now own two shares that are together worth Rs 300, whereas earlier, they had one share worth Rs 200 and an additional Rs 100 in cash.

Those who do not wish to take up the Rs 100 right can, instead, sell it in the market, where its price will be Rs 50, which exactly covers the decline in the stock price (from Rs 200 to Rs 150). The rights are coercive because a stockholder who does not contribute the Rs 100 of exercise price — or does not sell the right to someone who will do so — will suffer a price decline of Rs 50 without the offsetting gain of Rs 50. Therefore, existing shareholders will either exercise the rights themselves or sell them to someone who will. As a result, the rights offering is guaranteed to raise the desired amount of capital, which equals the number of rights issued times the exercise price per right.

An example of that is the rights issue of Banco Santander, the largest bank of Spain, which announced on November 10, 2008, that it would raise 7.2 billion euros through a rights issue.

The bank would issue one rights for each four existing shares, with the exercise price set at 4.50 euros, while the stock price was 8.34 euros. The bank said that the rights issue, which represented almost 14% of the bank's capitalisation, was intended to boost its core capital ratio. At that time, the bank's core capital stood at 6.31% of assets and was expected to drop. On November 28, 2008, the bank announced that investors had signed up for the entire issue.

Other major banks used coercive rights issues to raise capital. Among them are HSBC in 2009, where 97% of the issue had been subscribed, and Banca Popolare di Milano, with a subscription rate of 94%.

Importantly, selling the rights at a discount to the market value or the book value of the bank does not make the existing shareholders worse off because after they exercise the rights, they retain the same proportional ownership of the banks' assets. This is particularly meaningful in public sector banks, where the government is expected to exercise the rights and, thus, retain its share of control of these banks. The only purpose of the deep discount is to guarantee that the public shareholders contribute the desired amount, too, to shore up the banks' balance sheets and enhance their solvency.

From the government's viewpoint, this method of raising capital saves on its cost in keeping the banks solvent. Suppose a public sector bank is in a precarious situation. If it fails, the government alone will have to bail it Banout, thus, the entire onus of injecting new capital will be on the government. The public stockholders will, in fact, take a free ride on the government's guarantee.

In contrast, the rights issue ensures that the public stockholders too contribute — right now, ahead of the potential bank failure — to the stability of the banks. That is, the rights ease the government's burden in case of a bank failure by making more private equity capital available to the bank. To illustrate, the Union government has recently approved a capital infusion of Rs 12,517 crore into state-run banks over the coming fiscal year.

The government ownership in these banks is nearly 60%. Usage of coercive rights means that the government will be able to reduce its contribution to less than Rs 7,500 crore while retaining its ownership share intact, with the remaining amount in excess of Rs 5,000 crore coming from public shareholders. Suppose, on the other hand, a state-owned bank turns out to overcome the financial difficulty and the capital injection has been unnecessary. Then, the bank can distribute the excess equity that it has back to shareholders by way of dividend.

Because the government's share of the bank's equity remains unchanged before and after the rights' exercise, it will receive back exactly the amount it has contributed, with no loss to itself.

In summary, forcing troubled state-run banks — or any bank — to issue coercive rights to their shareholders can only help the government and not hurt it. It will greatly relieve the onus that the government is now subject to in its guarantee of the banks' solvency. It is desirable to do it now before problems erupt, because greater equity will preempt insolvency problems. The major benefit is having stable banks and a dependable financial system that will foster economic growth in India.


(Y Amihud is Ira Rennert Professor of Finance at the Stern School of Business, New York University, and T S Oncu is head of research at Cafral, RBI)

http://economictimes.indiatimes.com/opinion/comments-analysis/stabilising-indian-banks-through-coercive-rights/articleshow/18157343.cms?curpg=2