Why does a report on the banking sector have to make a distinction between the needs of private sector banks and public sector banks? The answer from the age old socialist mind set would be that the latter are national properties and about the rest, the less said the better. But if and when banking hubris strikes, will it make that sort of distinction? Otherwise there can be no reason for the committee on financial sector assessment (CFSA) to have decided the government may have to pump in Rs 49,552 crore for the 19 nationalised banks in the worst case scenario of a rise in risk weighted assets (aka bad debt) by 30% in the next four years.
This does not build up a case for nationalisation but given the circumstances the world is in, will it be possible for the Indian government not to move in if any of the private sector banks land in trouble? And since this is a risk assessment, it would be more valuable if the RBI and finance ministry factored in those risks too. But leaving that aside, has the committee examined the basis of a possible government bailout?
The best way to judge the financial soundness of a bank is to measure the value of its ordinary shares and reserves. There can be additional stuff, as for instance RBI has specified, but usually from a regulator?s point of view this is it. The ratio of this capital to its total risk weighted assets is known as Tier-I capital.
As on March 2008, the Tier-I capital ratio of Indian public sector banks stood at 7.9. For the entire commercial banking sector it was 9.1. The committee on financial sector assessment has rightly zeroed in on these figures to flesh out the capital adequacy of the banking system.
But the committee report does not say how the valuation of the tier I capital has been made. The share capital of the Indian banking system is assessed at book value. In the period from September 2008 to March 2009, the banking sector index slipped by 36% at the BSE. So, it is quite appropriate to assume that the value of the Tier-I capital has got eroded similarly. The gap from the safety margin as prescribed by the Basel-I and even more to Basel-II has expanded.
This means the estimated government support banks could need will be much larger than the Rs 49,552 crore. The erosion of the tier I capital due to the market meltdown has in fact not been addressed in this report at all. If one adds to this the erosion in the value of the Tier-II capital?bonds and other debt instruments?the order of support could be much more.
The committee is obviously aware of the possible scale of support a banking system in crisis imposes on the state. There is a chart of the clean up cost to the state as a percentage of GDP culled from 40 episodes across the world in the last 30 years. Whether one looks at the US which spent over 3% of its GDP to clear up its crises in 1981 to Argentina that spent 55%, the range is enormous. India has actually never had a crisis and has spent only about 1% of its GDP on recapitalisation of banks. Even the new figure would be just less than 2% of the Indian GDP in 2012. So, if history is any guide and the list shows that banking crises has struck all sorts of countries including France, Australia, Brazil and Thailand, the cost of clean up is far higher.
This is, therefore, a very good reason to worry that the current political unanimity to just do no reform in the banking sector makes it certain that the cost of a clean up will be enormous for the Indian public.
All this flows from the committee report. But what does not flow is equally a cause for concern. The report says despite its intention to do a stress test on the different parameters of the banking sector, that task has not been attempted. In Volume III, the chapter on Aspects of Stability and performance of financial institutions, it states that there are no time series data to do the stress tests. It has therefore asked for the development of a Financial Stability Unit which is building a central database. ?This core set of indicators is being used by the group for the monitoring and preparation of reports on financial soundness indicators on a regular basis. It is expected that the necessary time series would be in place in about two years, when it would be possible to develop models for having early warning signals and a set of variables that can be used for stress testing.?
So to know if the Indian banking sector is really in trouble or not, RBI will have to build up a data base for another two years. The RBI has said it will have to increase off site surveillance of banks to generate the data. But then one had presumed one of the key function of the bank was to track such data ab initio.
subhomoy.bhattacharjee@expressindia.com