Dubai: The Government of India’s decision to inject an unprecedented Rs2.11 trillion (Dh119 billion, $32 billion) into struggling state-run banks over the next two years, has come as a huge relief to leading public sector banks that have been reeling from mounting non-performing assets (NPAs) and struggling to meet the mandatory capital requirements.

The newly announced capital infusion includes Rs1.35 trillion through recapitalisation bonds over the next two years, with an additional Rs181 billion of direct support from the budget, and a further Rs580 billion to be raised from private investors.

The plan is almost triple the size of a recapitalisation plan announced two years ago, which has fallen short of its target after the banks struggled to supplement government capital by raising equity from the market.

Credit rating agencies such as Moody’s and Fitch said government’s plan to pump in more capital into these banks will bolster their risk buffers and support the financial system.

“The proposed infusion is a sizeable jump over what had been pledged before as India is seeking to plug a large part of the core equity gap at the state-run banks. This addresses “weak core capitalisation, one of the key drivers for our negative outlook on the South Asian nation’s banking sector,” said Jobin Jacob, associate director at Fitch Ratings.

Apart from stabilising the balance sheets of public sector banks, the recapitalisation move according to analysts is a requirement to fund faster economic growth. In this sense, this announcement sets the stage for an economic revival at a time the country has been facing slowdown in growth. Laden with the huge burden of accumulated NPAs over time, the loan growth has been tepid over the past few years.

With loan growth flagging at the struggling state banks in recent years, private-sector rivals have seized the opportunity to grow rapidly in both retail and corporate lending. According to analysts the recent recapitalisation move is unlikely to result in an immediate resurgence of lending by the state banks. “Slow loan growth — which fell to just 5.1 per cent in the last financial year, a six-decade low — is largely a result of companies’ weak demand for credit, which “needs to be worked at separately,” wrote Nilanjan Karfa, an analyst at Jefferies.

Credit weakness

Rating agency Moody’s said the recapitalisation of public sector banks is a credit positive for these banks. “The quantum of the plan is large enough to comprehensively address these banks’ weak capitalisation levels and is a significant credit positive as weak capitalisation is the main credit weakness for most rated public sector banks,” said Srikanth Vadlamani, a Vice President and Senior Credit Officer at Moody’s.

In addition to the support through recapitalisation bonds and budgetary support banks are now in a better position to access more capital from the markets “For the 11 rated public sector banks, Moody’s estimates that their external capital requirements over the next two years would be around Rs700-950 billion, factoring in the two main drivers of their capital needs — the need to comply with Basel III requirements, and for conservative recognition and provisioning of their asset quality problems,” says Vadlamani.

In addition, the inability of most these banks to access the equity capital markets has also been a key constraint on their capital levels. With much greater visibility now on these banks receiving adequate capital from the government, they may also accordingly regain market access. Analysts say there is significant scope for the government to reduce its current shareholdings in these banks and still maintain majority ownership.

Morgan Stanley is calling this India’s TARP — a reference to the US Troubled Asset Relief Program implemented in the throes of the financial crisis — and Indian stock markets welcomed the decision but bond investors were more circumspect.

Details on the program, including the structure of the recapitalisation bonds and allocations to individual banks, have not yet been disclosed. However, the government has announced that this program will be implemented over the next two years.

In the past, the government had used the recapitalisation bond route to recapitalise public sector banks. Those instruments typically had relatively long maturities and didn’t have much market liquidity. A similar structure this time would have some negative implications for the banks’ liquidity and profitability profiles.

Given the current credit weakness of the public sector banks analysts say the infusion is significantly credit positive for these banks and the banking system as a whole.