A bad government-owned bank is more capital efficient and can significantly lower the credit cost ratio

Amid confusing reports of proposed bad bank control, brokerage called for government ownership, saying state funding is more capital efficient in addition to speeding up implementation and also reduce the cost/loss of credit for banks.

The government that owns the proposed bad bank will not only be more capital efficient, but will also have no impact on budget figures, because otherwise it will have to continue to recapitalize state-owned lenders because they will be the biggest beneficiaries of the proposed bad bank, Bank of America Securities India said in a report.

Again, such a setup can reduce banks’ credit charges to one-fifth in the worst case from the current 100%, the report adds.

In March 2020, banks’ net non-performing loans stood at 2.8% or Rs 2,89,500 crore, or 1.3% of GDP, according to the report.

This will rise significantly to 13.5% by September, a two-decade high, given the impact of the pandemic on businesses and banks, according to the Reserve Bank of India.

In January, a central bank stress test showed that gross NPAs for public sector banks could fall from 9.7% in September 2020 to 16.2% in September 2021, while those for private banks by 4. 6% to 7.9% and foreign banks 2.5% to 5.4%, bringing system-wide bad loans to 13.5% by September this year.

It is understood that the proposed Asset Reconstruction Company or ARC will be funded by public banks/FIs.

According to the report, the proposed ARC to take over bad debts from banks offers an opportunity to improve asset quality when real lending rates fall.

But the question is, who will finance it? If the public banks/FIs fund it, the ARC will largely take over their bad debts, which were 2.8% in March 2020. In this scenario, the banks would then transfer their NPAs against security receipts issued by the ARC, he said.

But economists at the brokerage believe that a fully government-funded ARC will not only be faster to set up, but may also be more capital efficient.

More importantly, the capital charge of banks could be reduced from 100% to 0-20% if these security receipts are issued by a fully state-owned company, which will effectively be guaranteed by the state.

Fiscally this will have no impact as the government eventually has to recapitalize the banks anyway and so the potential fiscal impact is similar and it can easily dip into the RBI revaluation reserves to recapitalize banks in a budget-neutral and liquidity-neutral transaction. , says the report.

State funding can be faster and more capital efficient, he added.

The ARC’s capital requirement will depend on whether it is required to maintain a CRAR of 9% of RWA applied to banks or 15% applied to NBFCs.

If the government provides equity, it will have to recapitalize the write-offs anyway either as the owner of the ARC or as the owner of the public banks. Furthermore, it is unclear whether banks’ balance sheets can withstand the blow of a delayed recovery.

In any case, the government will end up implicitly guaranteeing at least the recapitalization of the PSBs.