Why it is in news?

• The Union government unveiled an ambitious plan to infuse 2.11 lakh crore capital over the next two years into public sector banks (PSBs)
• PSBs are saddled with high, non-performing assets (NPAs) and facing the prospect of having to take haircuts on loans stuck in insolvency proceedings.

Why it is needed?

• The move is vital for the slowing economy, as private investments remain elusive in the face of the “twin-balance sheet problem” afflicting corporate India and public sector banks reflected in slow bank credit growth.
• Several economists opine that the recapitalisation of banks — so that they can lend more freely and help revive private investment — is critical for revitalising the growth momentum at a time when the global economy is recovering.

Front-loaded funding

• Financial Services Secretary said the Union Cabinet had approved the capital infusion plan for PSBs, adding that the funding pattern would be front-loaded.
• The government has decided to take a massive step to capitalise PSBs in a front-loaded manner, to support credit growth and job creation,
• This entails mobilisation of capital, with maximum allocation in the current year, to the tune of about ₹2,11,000 crore over the next two years.
• This would be funded through budgetary provisions of ₹18,139 crore and the sale of recapitalisation bonds worth ₹1.35 lakh crore. The balance would be raised by the banks themselves by diluting the government’s equity share.

What is front load?

• To incur or pay off (expenses, for example) in an early period of a fiscal arrangement.

Indiscriminate lending as a cause of the problem

• Indiscriminate lending earlier by banks led to a high level of NPAs And these NPAs were kept under the carpet. Now they have come to light because of the Asset Quality Review conducted by the Reserve Bank of India.
• The capital infusion would also be accompanied by a series of banking sector reforms
• FM said the nature of the recapitalisation bonds would be decided in the coming months, adding that the impact from the capital infusion on the fiscal deficit would be determined by the type of bonds and as to who the issuing authority would be.
• The nature of the bonds will be decided in due course
• They will increase the lending capacity of the banks. The effect on the fiscal deficit will depend on the nature of the bonds and also how they are dealt with. Globally, the practice is to not include bonds in the fiscal deficit calculation. In India, we do include it 

What is bank recapitalisation?

• Bank recapitalisation, as the name suggests, means recapitalising banks with new capital to improve their balance sheet.
• The government, using different instruments, infuses capital into banks undergoing credit crunch.
• Capital is the money invested by shareholders in the business. Since the government is the biggest shareholder in public sector banks, the responsibility of infusing capital majorly lies with the government.
• The recapitalisation plan comes into action when banks get caught in a situation where their liabilities are comparatively higher than their assets.
• The liquidity with banks is a liability as it is the money deposited by customers, which needs to be paid sooner or later.
• Due to this their balance-sheet weakens and banks find it difficult to raise capital from the open market.
• The government, which is also the biggest shareholder, can infuse capital in banks by either buying new shares or by issuing bonds. 

How government plans to recapitalise public sector banks?

• The government is currently focused on maintaining its fiscal deficit at 3.2%. This means that the government cannot take out money from state coffers and give it to banks.
• Hence, the government bifurcated the entire Rs 2.11 lakh crore amount in two parts:
• First, through budgetary allocation and
• second, by issuing recapitalisation bonds. The government plans to infuse Rs 76,000 lakh crore capital by giving it space in budgetary allocation and through markets, and rest 1.35 lakh crore by issuing recapitalisation bonds. 

What are recapitalisation bonds? 

• A government bond is an instrument to raise money from the market with a promise to pay to repay the face value of the maturity date and a periodic interest. A bond issued for the purpose of recapitalisation is called recapitalisation bonds.

How will recapitalisation bonds work?

• The government will issue recapitalisation bonds, which banks will subscribe and enter it as an investment in their books.
• The banks will lend money to the government for subscribing the bonds. This money raised by the government through these bonds will go back to banks as capital.
• This will immediately strengthen the balance-sheet of the banks and show capital-adequacy.
• Since the government is always solvent, the money lent to the government for subscribing recap bonds is free from becoming a bad loan. 

Will it have an impact on the fiscal deficit?

• Since the government is not infusing money from the state coffers, it does not have an immediate impact on the fiscal deficit. However, it also depends on how it is being accounted in the books of the government.
•  According to Chief Economic Advisor Arvind Subramanian, under IMF accounting, it does not add to the fiscal deficit, but under India’s accounting, it does as sooner or later, the government would be liable to pay the interest and face value of the bonds.
• However, since it is a long-term debt, it provides time to banks to improve their balance-sheets by increasing their credit and private investment. The government, then, can retire the debt from the proceeds by selling the bank equities purchased earlier, once banks’ situation gets better.  

The cost?

• The interest burden of Rs 1.35 lakh crore recapitalisation bonds on the government would be about Rs 9,000 crore, but Chief Economic Adviser Arvind Subramanian says this cost can be offset by a spur in economic activities due to increased credit and private investment. 

Tried and tested formula!

• Between 1993 and 1995, the then government issued recapitalisation bonds to help distressed banks. According to media reports, as much as Rs 20,000 crore was infused into public sector banks through this method in the 1990s. 
• Not just to help distressed public sector banks, the government, in 2006 had announced the issuance of special bonds to the oil marketing companies.
• The government had issued bonds worth Rs 2,000 crore to three oil-marketing companies to compensate them for under-recoveries in their domestic LPG and Kerosene operations.