Many of the banks in India are experiencing serious financial trouble. These failing banks are in need of a bail-out, and they are willing to do almost anything to stay afloat. Luckily for them, they are owned by the Indian government, which has the ability to get them the money they need using a cunning and somewhat questionable strategy.
Of course, government-owned entities financing their own bailout went exactly as anyone could have expected it to. Let’s take a deeper look.
Why They Failed
Lenders in India survived the crises of 2007 and 2008 without much trouble. However, following this difficult time, they loosened their lending practices, approving applications for borrowers that were unlikely to ever repay their loans (sound familiar?). The number of loans in default continued to grow over time. Today, bad loans account for approximately 20 percent of the loans on the books among government lenders.
Unfortunately, even as the number of bad loans grew, these lenders did not want to admit that they had a problem. Admitting that borrowers wouldn’t be repaying these loans would lead to a loss, which would limit the money invested by shareholders and lower the bank’s equity. For state-owned banks, losing equity just isn’t an option. These banks already have some of the lowest equity levels in the industry.
Because of their incredibly low equity, these banks lost the ability to extend new loans. Bank-credit growth continued to fall, and has approached record lows. In response, year-on-year GDP growth fell from 7 percent to only 5.7 percent.
The Indian Government Steps In
The Indian government currently holds majority stakes in 21 different lenders in the country, which account for approximately two-thirds of India’s banking industry assets. To save these banks from certain ruin, the Indian government will borrow 1.35 trillion rupees, which amounts to approximately $21 billion, from these banks.
After receiving the money, the Indian government will reinvest it in bank shares, which will stabilize the banks and allow them to resume normal operations. Additional investments will occur over the next two years, bringing the total cost of the plan to over $32 billion.
After the banks receive the money they need from the Indian government, they will have the equity they need to begin operating more responsibly. They can acknowledge the bad loans on the books, and they can use India’s new bankruptcy code to deal with some of these borrowers. The increase in equity will also allow these banks to begin lending to new, more responsible borrowers again.
The news of the impending bail-out spread through India and the rest of the world quickly. This caused share prices for state-owned banks to increase rapidly. Currently, prices are up by at least 25 percent. Some lenders, such as Punjab National Bank and Bank of India, saw even larger gains.
Will it Be Enough?
Some analysts have praised the Indian government’s plan to bail out its state-owned banks as a much-needed and significant strategy that will help to revive the nation’s struggling economy. However, other analysts question whether this bail-out will be enough to recover the banking industry.
This isn’t the first time India’s state-owned banks have needed help from the government. New Delhi issued a large bailout to these same banks in the 1990s, in addition to several smaller infusions of cash over the years between 1990 and today.
CNN Money reports that this bailout won’t be sufficient to bring Indian banks into compliance with new international regulations set to go into effect in 2019. In order to comply with these regulations, state-owned banks in India are likely to need even more help over the next two years.
In addition to the lack of sufficient funds, other issues within India also add to the uncertainty. For example, India is currently undergoing many changes to its taxation structure, which is having a negative effect on the banking industry. Likewise, because private banks have been filling the lending gaps in recent years, state-owned banks may not be able to open new accounts right away, even with the extra equity.
Some analysts point out that the fact that Indian state-owned banks continuously need help from the government indicates an underlying problem with the way these banks do business. One possible explanation stems from the fact that they are public-sector banks, which subjects them to constant political pressure. As such, they often make decisions based on short-term political goals, instead of considering what is best for the future of the bank.
To combat this problem, some experts suggest that the Indian government should sell off at least some of its shares in these banks.
Now, all analysts can do is wait and see if India’s financial sector is fixed on repeating history.
Regards,
Ethan Warrick
Editor
Wealth Authority
