Lessons from History of bank recapitalisation bonds issued in 1993-94…

Talk about political ironies really. One one hand the current government continues to hold previous government for all India ills and on the other keeps picking policy solutions from the same government.

On this Tuesday, Government announced a public sector bank bailout sorry recapitalisation plan worth Rs 2.11 lakh crore. The plan will have two components:

Out of the total commitment, Rs1.35 trillion will come from the sale of so-called recapitalisation bonds. The remaining Rs76,000 crore will be through budgetary allocation and fundraising from the markets.

The bank recapitalisation package marks a sharp increase over the current budgetary allocation. Under the Indradhanush plan, the government has allocated Rs20,000 crore towards bank recapitalisation over the current and next fiscal years.

Interestingly, the same plan was approved by the Indian government in 1993. The then Finance Minister Dr Manmohan Singh in Budget speech of 1993-94 said:

Because of the new norms, however, banks will have to make large provisions amounting to over Rs.10,000 crore for bad and doubtful advances in
their portfolios. As the provisioning norms are being introduced in two stages, the first impact will be felt in the year ending 31 March 1993, with a further impact next year. The resulting losses will eat into the capital of the banks, which is already inadequate given the new capital adequacy norms.

In order to protect the viability and financial health of the Indian banking system I am making provision for a large capital contribution of Rs.5,700 crore to the nationalised banks in 1993- 94 to meet the gap created by the application of the first stage of the provisioning norms.

There will be no immediate net outgo from the budget, as the Government’s contribution is in the form of Government bonds; but the interest payment on these bonds, and their ultimate redemption will be a real burden on the budget in future. This is the price we have to pay for having long tolerated management practices in the banks and types of lending which paid inadequate attention to portfolio quality and recoveries. I may add that while undertaking such a large injection of capital into the banks, specific commitments will be required from each bank to ensure that their future management practices ensure a high level of portfolio quality so that the earlier problem does not recur.

Even this large injection of capital will only solve the immediate problem. Additional losses will arise because of the second stage of provisioning next year. Besides, the capital adequacy requirements are also being introduced in a phased manner and there will be additional capital needs on this account in 1994-95 and 1995-96. This burden cannot be borne entirely by the budget without eating into scarce resources which are desperately needed for development, especially in the rural areas. Government has, therefore, decided that the State Bank of India, as well as other nationalised banks which are in a position to do so, will be allowed to access the capital markets to raise fresh equity to meet their shortfall in capital requirements over the next three years. The additional capital thus moblised will help our banks to expand their lending which would otherwise be constrained by capital inadequacy. Government will, continue to retain majority ownership, and therefore effective control, in the public sector banks. Necessary legislation to give effect to this decision will be introduced later in the year.

RBI’s History Volume (1981-2007) provides some details of the allocation to the 19 nat banks:

In Rs crore % of total
Recapitalisation bonds Capital and Reserves Recapitalisation bonds Capital and Reserves
ALLAHABAD BANK 90 26941.3 1.6 4.0
ANDHRA BANK 150 14720 2.6 2.2
BANK OF BARODA 400 59124.94 7.0 8.7
BANK OF INDIA 635 66682.14 11.1 9.8
BANK OF MAHARASHTRA 150 19825 2.6 2.9
CANARA BANK 365 107656.57 6.4 15.8
CENTRAL BANK OF INDIA 490 23273.13 8.6 3.4
CORPORATION BANK 45 9337.56 0.8 1.4
DENA BANK 130 14932.79 2.3 2.2
INDIAN BANK 220 47947.75 3.9 7.0
INDIAN OVERSEAS BANK 705 41179.67 12.4 6.0
ORIENTAL BANK OF COMMERCE 50 16400 0.9 2.4
PUNJAB AND SIND BANK 415 21409.08 7.3 3.1
PUNJAB NATIONAL BANK 160 54878.25 2.8 8.1
SYNDICATE BANK 680 18861 11.9 2.8
UCO BANK 535 51591 9.4 7.6
UNION BANK OF INDIA 200 24156.24 3.5 3.5
UNITED BANK OF INDIA 215 48138.5 3.8 7.1
VIJAYA BANK 65 14355.85 1.1 2.1
Total 5700 681410.77 100 100

Not sure how the allocation was based. I have just looked at share of capital and reserves and it matches for some but not for others.

Further these bonds were notified as 10% recapitalisation bonds on Jan 1, 1994.The features of the bonds were:

  • 10% interest paid half yearly
  • Bonds to be repaid in 6 equal installments from Jan 1, 2001
  • Transferable
  • Non-SLR
  • Banks could use them to obtain loans from other banks/Financial Institutions

The key idea was that there would be no impact on the budget immediately. How was this done? Let us see it via the balance sheet approach:

1.The first step is government issuing bonds.

                      Govt
Liabs                                   Assets
Recap Bonds    5700

2.The next step is banks subscribing to these bonds.

                       Banks
Liabs                                   Assets
Cash to Govt 5700               Recap Bonds    5700

3. The government receives the money from the banks.

              Govt
Liabs                                   Assets
Recap Bonds    5700             Cash from Banks     5700

4. The Government just converts this cash towards equity investment in banks

              Govt
Liabs                                   Assets
Recap Bonds    5700             Cash from Banks      0
Equity in Banks       5700

5. The Banks looks like this now:

                     Banks
Liabs                                          Assets
Equity from Govt 5700               Recap Bonds    5700

4.The banks receive interest on these bonds. Infact, RBI reported profits of nationalised banks exclusive of income from recapitalisation bonds. From 2001 onwards, the government even begins to payback principal on the bonds. At the end of it all the Banks balance sheet looks this:

                 Banks
Liabs                                          Assets
Equity from Govt 5700               Recap Bonds    0
Profits/Reserves (570*12)         Cash                 5700+ (570*12 as interest)

So it is hardly a free lunch as we were told then and we are told today. These are also lessons on how money is typically created by banks from thin air.

Then in subsequent Budget speech in 1994-95, FM Dr Singh updated the Parliament:

Honourable Members are aware, we have embarked on a basic restructuring of the banking system aimed at ensuring full financial viability of its
operations and strengthening its competitive capability. I provided a sum of Rs.5,700 crore as capital contribution to the nationalised banks in 1993-94 to help them make necessary provisions against bad and doubtful loans and meet the new capital adequacy norms. I had indicated last year that there would be additional capital needs in 1994-95 and 1995-96 and also that this burden could not be borne exclusively by the Budget.

I am happy to report to the House that in December 1993 and January 1994, the State Bank of India successfully raised over Rs.2,200 crore from the public through issue of equity and another Rs.1,000 crore through a bond issue.

To allow the nationalised banks to access capital markets in the same way, and mitigate the burden on the Budget, legislative amendments were
introduced in the Lok Sabha in the Winter Session. Their speedy passage will help many of these banks to mobilise the capital they need to meet their requirements. 

Many nationalised banks will nevertheless require additional support during 1994- 95 and I am providing Rs.5,600 crore in 1994-95 as additional capital contribution for these banks. As before, this capital will be provided in the form of Government bonds on which there will be no immediate cash outgo. Interest payments and amortisation will of course be a charge on future budgets.

So there were subsequent bond issuances. MS Verma Committee floated to look at health of PSBs sums up:

As stipulated by the Reserve Bank of India, banks were required to attain capital adequacy ratio of 8 per cent by 31 March 1996. Since quite a few public
sector banks were not fulfilling this requirement, Government of India had to infuse fresh capital in all the 19 nationalised banks. Under this programme, the government infused as capital Rs. 6,400 crore in 1993-94 and a further Rs. 4,362 crore in 1994-95. The capital infusion was through issuance of bonds carrying fixed coupon rates initially at the rate of 7.75 per cent per annum which, in subsequent issues, was raised to 10 per cent. Besides this, under the project sponsored by the World Bank for capital restructuring, the government availed of US$ 150 million as retroactive finance and provided these funds to six public sector banks by way of subordinated debt for their modernisation initiatives. In all, the Government of India has so far spent Rs. 20,446 crore on recapitalisation of the nationalised banks.

All fairly complicated. I did try and get some estimate of these bonds in the Budget documents etc, but got nothing as these bonds were not supposed to impact the budget rightaway. It was passed onto future budgets but could not find anything in future budgets as well.

Later there was this news shows that these bonds were converted to perpetuities and there was more financial engineering involved:

The government on Saturday revised fixed coupon rate of 10 per cent and extended the tenure of the recapitalisation bonds, worth over Rs 5,000 crore, issued to nationalised banks.

As per the revised format, the coupon rate on these bonds issued to over a dozen nationalised banks, would be linked to the yield on Government of India 364-day Treasury Bills, with additional one per cent over the average yield on these bills.

The tenure of the 12-year bond had been converted into “perpetuity” and made non-transferable. The decision was taken at a meeting of Cabinet Committee on Economic Affairs (CCEA), which met here on Saturday.

 The government had issued recapitalisation bonds, bearing a 10 per cent interest, to augment the capital base of public sector banks, including Bank of India, Indian Bank and Punjab National Bank, during 1993-95. Announcing the decision, Finance Minister Jaswant Singh said these bond would be redeemable only as and when the bank returned the capital as part of the banks” restructuring programme.

Phew! So unless banks paid back the capital raised via this route they would not get the principal from the bonds!

The more you try and figure this, the more confusing it gets.

In net net terms, all these off balance sheet bonds are hardly anything new. They are just tricks which postpone the payment terms later.

One does not know the design of this new scheme but it is also based on same principles and assumptions.

Experts are touting this as a big reform and saying now all we need is governance reforms. One is not sure based on how much financial engineering has gone in all this. One was really surprised to read the statement from the reticent RBI above all who should know that all these are just financial tricks.

A transparent capital raising method was the need of the hour telling markets clearly that there is no free lunch here.

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9 Responses to “Lessons from History of bank recapitalisation bonds issued in 1993-94…”

  1. Rohit Srivastava Says:

    Equity investment in banks is an Asset

  2. ram Says:

    can you say what will be the impact on bond market? And then what if govt issues zero coupon bond instead of coupon bond because coupon bond will have impact on fiscal deficit due to interest payments.

  3. Linkfest - Kairos Capital Says:

    […] Mostly Economics – Bank Recap: Old wine in new bottle? […]

  4. Sushil Prasad Says:

    Proposed recapitalisation does not address any of the issues which have brought our banks to present state of mess – directed lendings, political interference, weak managements, excessive micro-management by RBI, outdated conceptual framework under which most lending is practiced in India, insufficient stress on providing safe, reliable, and easy savings instruments etc.

    I am trying to figure out total amount of funds poured into PSU banks since say 1991 – that is since serious attempt of overhauling Indian banking system started with Narasimham – I.

    Have been getting bits and pieces of unsubstantiated information from various places. Anyway to vet it or get validated figures?

    • Amol Agrawal Says:

      You have nailed it Sushil. But look at the analysts supporting the recap plan and how markets reacted to the decision. On getting the figures on funds provided to banks, all I can say is welcome to the Treasure Hunt club 🙂 I mean it is so difficult to find all this basic information at anyone place that it is like a Treasure hunt.

  5. Sushil Prasad Says:

    The proposed recapitalisation should have been used to usher in desired governance reforms. Without it, its just more money down the drain.

    To give a rather graphic and gory analogy, it is like a patient approaching end stage renal failure who urgently needs dialysis, but there seems to be no attempt to understand or rehabilitate the patient with measures which would either make existing kidneys functional or arrange for a transplant which would enable the patient lead a near normal life.

    Getting patients to remain hooked to dialysis machines in perpetuity is a trivial solution!

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