Late last week, the Reserve Bank of India (RBI) put a moratorium on the withdrawals of deposits from Yes Bank, the fourth largest private sector bank in the country.
The interesting thing is that the Yes Bank crisis feels worse than the bad loans crisis of public sector banks. Bad loans are largely loans that haven’t been repaid for a period of 90 days or more.
In this piece, I will try and show why public sector banks seem to be much safer than private banks like Yes Bank even though they aren’t, and how we are paying for this so-called safeness without really being aware of the same. Oddly, no one is really talking about this as well.
In a way, public sector banking in India has become like environment. The cost of what we do to keep it going will be borne not by us, but by the next generation. The sad part is no one really realises it.
As of September 30, 2019, the bad loans rate of Yes Bank had stood at 7.4 percent. This means that out of every Rs 100 of loans that the bank had given out, Rs 7.4 hadn’t been repaid for a period of 90 days or more.
The results for the period of July to September 2019 are the latest results available in the public domain. Of course, it’s safe to say that things have deteriorated for Yes Bank since then. There has clearly been a run on its deposits, which finally led to the RBI limiting the withdrawal of deposits to Rs 50,000. Also, from what it seems, the bank hasn’t been reporting its numbers properly.
Even after taking these factors into account, the crisis in Yes Bank is not as bad as many public sector banks, where bad loans rates even crossed 20 percent. Take the case of Indian Overseas Bank. The bad loans rate of the bank has been higher than 25 percent at some point of time. IDBI Bank has been in similar territory. The Central Bank of India and the United Bank of India have had bad loans of more than 20 percent at different points of time. There are a whole host of public sector banks which have had a bad loans rate of 15 percent or more.
The question is: why have these banks not felt the pressure of deposit withdrawals, and why has there been no moratorium put on deposit withdrawals from public sector banks?
Let’s look at this issue pointwise.
1) Fourteen private banks were nationalised in 1969. Another six private banks were nationalised in 1980. Due to this, there is great faith in public sector banks. The assumption (and rightly so) is that they are backed by the government. This faith essentially ensures that people and firms continue to have their deposits in public sector banks, despite the mess that they are in.
Let’s take the case of 11 public sector banks that the RBI had put under the Prompt Corrective Action (PCA) Framework. What was the PCA Framework? Viral Acharya, who was a deputy governor of the RBI, explained this best in simple English, when he said: “Undercapitalised banks could be shown some tough love and be subjected to corrective action…Such action should entail no further growth in deposit base and lending for the worst-capitalised banks. This will ensure a gradual ‘runoff’ of such banks, and encourage deposit migration away from the weakest PSBs [public sector banks] to healthier PSBs and private sector banks.”
The idea was to basically discourage public sector banks under the PCA Framework to carry out any fresh business and give them time to heal. The banks put under the PCA Framework were Allahabad Bank, United Bank of India, Corporation Bank, IDBI Bank, UCO Bank, Bank of India, Central Bank of India, Indian Overseas Bank, Oriental Bank of Commerce, Dena Bank, and Bank of Maharashtra.
Between March 2017 and March 2019, the overall deposits of these banks shrunk by just 2.5 percent. This shows the faith that people have in public sector banks in India. Despite many of them being in grave trouble, their deposit base, on the whole, held up. Yes Bank did not have the same kind of luck.
(This is not to endorse any of the possible promoter shenanigans at Yes Bank. I am trying to make a much broader point here about public sector banks getting into trouble and private sector banks getting into trouble, and what they end up facing after that.)
2) The business model of banks at its very basic level is very simple. They raise money as deposits by paying on interest on them. These deposits are then given out as loans. The interest charged on these loans is higher than the interest paid on the deposits. The difference in these interests is the profit that the bank makes.
The assumption here is that the individual or the firm taking on the loan will repay it in the days or years to come. If the loans are not repaid (partly or wholly), beyond a point the bank is not in a position to wholly repay the deposits as they mature. But as we know, public sector banks have continued to repay deposits and, at the same time, there has been no moratorium put on withdrawals from these banks. So, what is happening here?
3) The public sector banks have managed to keep repaying their deposits. To keep these banks going, the government — as the major owner of the public sector banks — has invested fresh money or capital in the banks every year. The question is, where did this money come from? A lot of it was a simple allocation in the yearly budgets which was used to recapitalise the public sector banks. Take the years 2016-17 and 2017-18, when the government spent Rs 25,000 crore and Rs 24,997 crore, respectively, from budgetary allocations. It had to actually earn this money through taxes and then use it to recapitalise the banks.
This cost of recapitalising public sector banks is borne by the entire country, though most of us don’t know about it. This money (close to Rs 50,000 crore) could have easily been used to make better roads, to improve our defence capabilities, to improve Indian Railways, and so on. This is the unseen cost of rescuing public sector banks, which most of us aren’t aware of, and which makes the Yes Bank crisis seem much graver than it actually is. In this case, the costs of the rescue (like the State Bank of India coming in as an investor, or the RBI giving a loan to the Yes Bank) are all there upfront to be seen by everybody.
4) In October 2017, the government announced that it would use recapitalisation bonds to recapitalise the public sector banks from now on. This is where things got even more interesting. Thanks to the demonetisation of Rs 500 and Rs 1,000 notes, public sector banks were sitting on a lot of deposits that they had been unable to lend out. The government issued recapitalisation bonds, which were bought by the public sector banks using their deposits. The government then used this money to invest in the public sector banks and thus helped them shore up their capital.
Basically, this is how the government borrowed the deposits of banks and invested it in the banks and turned it into capital.
5) The recapitalisation bonds were supposed to have a tenure of 10-15 years and till date have paid anywhere between 7-8 percent interest to the public sector banks buying these bonds. In 2017-18 and 2018-19, the government issued recapitalisation bonds worth Rs 80,000 crore and Rs 1,06,000 crore, respectively. Between the announcement in October 2017 and September 30, 2019, the government had issued recapitalisation bonds worth Rs 2,50,814 crore. Banks bought these bonds using their deposits. The government reinvested this money in the banks and helped them recapitalise. This kept the banks going.
In the case of IDBI Bank, the Life Insurance Corporation of India, as its new owner, has been pumping in thousands of crore to keep it going. In that sense, the policyholders of LIC are paying for this in the form of lower investment returns. (Of course, they don’t know about it as well.)
6) Before October 2017, whatever money the government had invested in the PSBs came from budgetary allocations. This meant that the government had to earn or borrow this money from somewhere. The money that was used to recapitalise the PSBs could have been used somewhere else, which it was not.
Also, higher the amount of money that the government invested in PSBs to recapitalise them, the higher was its expenditure. The higher the expenditure, the higher its fiscal deficit would be. Fiscal deficit is the difference between what a government earns and what it spends.
By issuing recapitalisation bonds, the government took the problem of the increase in the fiscal deficit simply out of the equation. This way of recapitalising government banks was what economists called “budget neutral”. The government was taking money from banks by issuing bonds and then using that money to recapitalise the banks. Hence, to that extent, it wasn’t spending money earned from taxes or borrowing money to recapitalise the public sector banks. And given that, its expenditure wasn’t going up because of this. Hence, there was no impact on fiscal deficit at this point of time.
7) Having said that, the government has to pay a regular rate of interest to public sector banks buying these bonds. This interest adds to the government expenditure as well as the fiscal deficit. Over and above this, the bonds will have to be repaid, as and when they mature in the years to come. Even this money will have to come out of the government coffers. Also, the public debt of the government goes up because of this. Someone will have to pick up the tab for this in the years to come.
As Arun Jaitley said in his first budget speech as the finance minister in July 2014: “Fiscal prudence to me is of paramount importance because of considerations of inter-generational equity. We cannot leave behind a legacy of debt for our future generations. We cannot go on spending today which would be financed by taxation at a future date.”
Clearly, more than Rs 2,50,00 crore has been added to the public debt of the country, thanks to these bonds, and this number will only continue to go up in the years to come. In that sense, this is not a free lunch, as it might seem.
8) Up until 2017, we bore the cost of rescuing public sector banks without really knowing about it. Since then, the government has managed to pass on the cost of rescuing public sector banks to future generations. They will not know about it either.
Most analysts and economists are, as of now, concentrating on what will happen to Yes Bank in the days to come. While that is important, what is more important are the unseen effects.
With Yes Bank in a mess, the idea that public sector banks are the best will grow stronger in the minds of people, politicians and policymakers. This will mean that the government will continue to own a bulk of the banking sector in the country. And when it owns a bulk of the banking sector in the country, it will continue to have to keep rescuing it. Any rescue costs money, irrespective of whether it is being paid for now or in the future.
To conclude, public sector banks are not safe. They seem safe because the government quietly keeps recapitalising them by converting their deposits into fresh capital which is invested in these banks. But all this comes at a cost, which we are paying for. It’s just that we are currently unaware of it. And that’s the sad part.