Boost banks’ equity bases and get them to lend; else the economy will sink further
The unfortunate truth is that until companies are back on their feet, the economy is going nowhere; a 5% contraction in FY21 could well spillover into FY22 as well. But, where is corporate India going to source affordable money to restart and run businesses? A handful of A-listers apart, most are going to be scrounging for loans at a time when banks are looking the other way, and PE and FPI investors are turning picky. The government has offered to guarantee Rs 3 lakh crore of credit for MSMEs, and announced a Rs 30,000 crore line of credit for NBFCs. However, even at the best of times, the government or RBI directly buying corporate bonds—especially poorly rated assets—is a bad idea. It is a moral hazard as much as a bad bank is.
Instead, find a way to make banks lend by giving them both financial, and moral support. The best way out, is to let government capitalise state-owned lenders, even if it needs to borrow from RBI to do so. The borrowing could be made off-balance sheet, by issuing short-term bonds, so that there is no immediate pressure on the fisc. Right now, the PSU banks fear they will run out of capital given how NPAs are going to start piling up—even if a fourth of the loans for which repayment moratoriums have been offered slip, it would erode their capital bases badly.
While PSU banks currently have capital ratios that are above the regulatory thresholds at 9-11%, Credit Suisse estimates that, given low profitability, the ability to absorb loan losses is barely 200 bps. So, even if there is a half-good business in trouble, banks are reluctant to consider any additional assistance.
A chunky $12-15 billion (Rs 90,000-Rs 1.12 lakh crore) infusion, to begin with, could do the trick. It would leave banks feeling a lot more confident of lending to businesses that may not be top-grade, but are operationally sound. While a bad bank that ‘buys out’ stressed assets would make banks complacent since the exposure goes off the books, money put directly into banks would ensure they take their loans seriously.
A bad bank also allows promoters to get away without insolvency proceedings. One could argue that the additional capital, too, might not drive banks to lend. While not forcing them to throw good money after bad, the government must insist the fresh capital be used to lend to enterprise that have a fairly good chance of surviving. To be sure, there could be an element of subjectivity in some decisions, but government must ensure banks do take calculated risks; they could arm themselves with more collateral if needed, and ask for personal guarantees. But, lend they must; the capital cannot be lying idle.
Getting bankers to lend, though, needs more than adequate capital, vital though that is. There is the dreaded fear of the 3Cs and, while the government claimed to have fixed the Prevention of Corruption Act (PCA) that holds bankers liable for almost any loan decision, it is not clear the problem has actually been resolved. Why else would the government do so many iterations of fixing-the-PCA over the past few years?
FM Nirmala Sitharaman can’t fix lending until the law is fixed. One must understand that the credit environment has never been worse. At one level, bankers’ fears are justified because, on average, a dozen companies are downgraded each day. Credit Suisse has estimated the amount of debt already downgraded, to ratings that are likely to make refinancing challenging, at a frightening Rs 2.5 lakh crore. But, there are likely to be hundreds of units that are not in dire straits and could bounce back with some additional working capital.
While restructuring debt is never a good idea, RBI could make an exception, given the circumstances are unprecedented. That, then, would leave banks feeling a little more comfortable. However, it should be remembered the CDR mechanism was a complete failure, causing banks huge losses. This time around, rather than allowing a blanket restructuring, the terms and conditions should be framed such that not every company would be eligible. The eligibility criteria should be benchmarked to both the current financial metrics, and future cash flows.
Only when the loan market gets going will the bond markets unfreeze; spreads on longer rupee corporate notes are widening to levels last seen during the 2008-2009 crisis, even though repo is close to two-decade lows. Very soon, only AAA paper will be traded, with investors staying away from even borrowers rated AA.
The lack of liquidity in the bond markets will further put off FPIs, who have utilised just 37.5% of the quota in corporate bonds, partly because hedging costs have risen and the rupee has depreciated. Also, it is unlikely that there will be an encore of the $22 billion dollar bond issuances of 2019. Loan growth cannot be languishing at 6% if GDP is to grow at 6%. If the economy is not to sink further, the banks have to rise to the occasion.