The capital conundrum of nationalised banks

Updated: May 23 2007, 05:30am hrs
The banking industry, unlike most others, has a regulatory need for capital. Regulators force banks to hold capital to the tune of at least 9% of their total assets to ensure they can meet depositors claim on their money and maintain a robust financial system. This regulatory requirement is called the capital adequacy ratio (CAR). The RBI has cautioned that this will rise further to 10% in the near future.

The Indian banking industrys total assets have grown at 16% per annum since 2000. This has allowed assets to roughly double every four years. If the industry were to continue to grow at the same rate, it would again double its assets in four years. That would mean that there would be Rs 22,59,975 crore as additional assets that would be added by 2010. Such growth, if supported by a minimum cushion of 9% of capital, would mean an additional requirement of roughly Rs 1,50,000 crore. The cost, as it were, of high growth for Indian banks is their relentless need for capital.

Capital can accrue in one of two waysretained earnings or by raising fresh capital from the public. Indias nationalised banks face a peculiar problem here. By statute, they are to be owned at least 51% by the government. At their current level of profitability, this can cause them to lose market share if the government does not pump in more capital. The current CAR of public sector banks sits at a pretty 12.25%. But the projected growth in assets by 2010 would lead this ratio to fall to 6.8% at current levels of capital. To keep the CAR at the required level, public sector banks alone would need to raise about Rs 60,000 crore (including the amount of retained profits ploughed back in) of capital. Public sector banks, on average, give a return of 0.83% on assets.

With the banking industry in India growing at 16% per annum, for public sector banks not to lose market share, they will need to go to the capital market repeatedly for funds over the next three years
Even if one were to improbably assume that they could plough back all their capital to fund their growth, they would not be able to grow faster than 14%. Given the normal amount of dividend payments, they will not be able to grow at more than 10% per annum. With the banking industry in India growing at a hearty 16% per annum clip, for public sector banks not to lose market share, they will need to go to the capital market repeatedly for funds over the next three years.

This brings us to the issue of public sector banks ownership. The fact that they cannot dilute the governments stake to below 51% is a real problem for some public sector banks. The government stake in them is down to the regulatory minimum already. The three nationalised banks in this category are Andhra Bank, Dena Bank and Oriental Bank of Commerce. That means their growth is now restricted to the amount they can plough back from retained earnings, unless the government recapitalises them. Then, there are other major banks with the governments stake only a little above majority-control level, including State Bank of India, Punjab National Bank and Bank of Baroda. In fact, the government holding in nationalised banks is at about 62%or at about Rs 71,275 crore. These numbers are lower in terms of capital than the CAR because here we only talk about 51% of the ratios tier 1 portion, which is 4.5%. But even with this lower target, some banks will lose share unless the government pumps in money.

The government could rebalance its portfolio of holdings in a cash-neutral manner by selling some bank stakes and buying others. But it can do this only once and delay the day of reckoning by a few years. At the current growth rate in the sector, the same question will arise later. It also begs some key questions. Is it not quaint that the governments ownership prevents its banks from growing at the market rate Or, more fundamentally, does it need to own as many as 20 banks

Janmejaya K Sinha is managing director, BCG India. These are his personal views