The recapitalisation season

Updated: Feb 6 2002, 05:30am hrs
In my column of December 12, 2001, I had expressed fears of the Industrial Finance Corporation of India bailout becoming a precedent which would trigger a clamour for more bailouts. The ghost of the Rs 1,000 crore IFCI bailout predictably came to haunt the government as irresistible pleas would be made to provide booster doses of recapitalisation. What is more distressing is the manner of providing assistance. The State Bank of India and the Industrial Development Bank of India have sizeable non-government shareholders and these shareholders would be well within their rights to agitate over the bailout.

The IDBI bailout is going to be a much larger operation and the government would not be able to find compliant institutions which would be able to pick up a tab of Rs 3,000-5,000 crore. One only hopes that the size of the bailout operation would baulk the government into inaction. The talk of an Asset Reconstruction Company with an initial capital of Rs 1,400 crore does not really sound a good idea. If a large number of banks and institutions are to provide the initial capital, it would point to an industry-wide ARC. Now it is difficult to believe that an ARC, however well-manned, would be able to recover the non-performing assets any better than the bank which has hands-on experience of dealing with the borrower. The basic fact is that without a meaningful bankruptcy law and speedy foreclosure processes, any ARC would be of only cosmetic value as it would merely be an accounting entry to show a clean balance sheet for the concerned bank. The paradox in the Indian situation is that, however bad the balance sheet, a bank would be able to raise capital from the market merely by enticing gullible depositors, arm-twisting errant borrowers and playing on the sentiments of the employers (the only problem would be Securities and Exchange Board of Indias compliance on showing consistent profits before a market issue)! It would be irresponsible to let such banks go to the market merely with a dressed up balance sheet.

All this admittedly does sound negative and advocates of recapitalisation would argue that their approach is a positive one which at best has a chance of success. But, before drawing any definitive conclusions on this issue, let us see the track record of the three banks: Uco, United and Indian. If we are to believe what we are told, Uco and United have turned the corner, and can now legitimately move out of the weak category. The government/Reserve Bank of India undertook detailed bank-wise rehabilitation studies in the mid 1990s. It would be useful to undertake a high-powered independent study to verify whether these banks have indeed turned the corner and how this has been achieved. One fervently hopes that such a study will not throw-up more headaches for the government.

The Indian Bank provides an interesting study. The bank has reportedly undertaken a bootstrap operation. This does show that the leadership provided by top management does make a difference. It would be an error if a recapitalisation of Rs 950 crore were undertaken now merely to accommodate the banks requirements in Singapore. The Verma Panel had recommended that overseas operations and subsidiaries of weak banks should be sold off to other public sector banks or closed and this is where the solution lies, rather than providing large recapitalisation under the threat to a few overseas branches. The Indian Bank performance in the recent period is commendable as a bootstrap operation and this effort should be encouraged rather than the soft option of large recapitalisation. What should be worked out in detail with the Indian Bank is a path of restoration of capital adequacy and from a negative eight per cent at present to the present prescribed nine per cent, the bank needs to be given a time frame of say five years in which to attain the prescribed norms.

The RBI has already shown considerable forbearance and there is no reason why the RBI cannot continue in that mode provided the Indian Bank is on the track to restoration of capital adequacy. Over the five year period, the restoration of capital adequacy could be on a matching basis between internal generation and injection of funds by the government. In fact the recent efforts of the Indian Bank could be the model for other banks which get into difficulties. In retrospect, not yielding to pressures to fully recapitalise the Indian Bank during the period 1998-2002 has proved to be the correct decision and the government should persist with the policy of bootstrap operation. The forte of the Indian Bank is deposit taking, particularly savings bank deposits, and the bank should build itself on its strengths. Lending has never been the banks strength and we should not try to artificially make the Indian Bank a lending race horse.

It appears that the government is veering round to a trust structure for the ARC as it would obviate many problems in transfer of assets etc. The ARC envisaged in Narasimham II was of a very different genre than the Asset Reconstruction Fund of Narasimham I. The emphasis in Narasimham II was to develop an ARC as a commercially viable venture. Ab initio, the ARC, as presently envisaged, is focused more on getting the assets off the banks books rather than running the ARC as a commercially viable venture. The acid test for a commercially viable ARC would be to avoid forced subscriptions to the ARCs capital but to enable an ARC to be set up entirely in the private sector. The government could, at best, provide certain sops to the ARC in terms of say attractive tax breaks such as a 5-10 year exemption from income tax. The ARC should be free to negotiate with the banks what kind of loans it would take over after undertaking due diligence on the value of the security. The fear one has is that the ARC, in the absence of rigorous safeguards, could end up as a morgue for the dead bodies of advances made by the banks. The government would do well to use bureaucratic brilliance to slow down the proposed ARC so that the modalities are fully understood. The way the ARCs initial capital is being mobilised gives the impression that the capital subscriptions are being provided through diktat rather than commercial considerations.