Andy Mukherjee is a Bloomberg Gadfly columnist covering industrial companies and financial services. He previously was a columnist for Reuters Breakingviews. He has also worked for the Straits Times, ET NOW and Bloomberg News.

It's not just taxpayers who will make Indian banks whole. Tax cheats are being pressed into service as well.

Share prices of poorly capitalized Indian lenders have collapsed
Source: Bloomberg

State-run Indian lenders are gasping for breath, as the central bank forces them to recognize bad loans and make provisions. The 250 billion rupees ($3.7 billion) in fresh capital that Finance Minister Arun Jaitley has pledged to them from his annual budget -- with a promise to give more if needed -- will barely cover a couple of quarters of losses. Last month, Standard & Poor's cut its rating outlook on Bank of India to negative from stable and placed another government-owned lender, Indian Overseas Bank, on ratings watch.

But there's something else in Jaitley's budget that could prove a bonanza for banks: a one-time amnesty for tax defaulters. 

Nobody quite knows just how much undisclosed income is sloshing around in the domestic economy. But the last time the Indian government gave a general amnesty from prosecution in 1997, it collected $2.56 billion, or 0.6 percent of GDP.  A similar mop-up today could fetch $13 billion. The take-up this time might be somewhat lower because Jaitley is calling for a 45-percent levy on money that's been squirreled away illegally into real estate or converted into gold bars. In 1997, the tax rate on voluntary disclosure was a more ``reasonable'' 30 percent.

Even if the government collects, say, $10 billion, it would still free the other 55 percent of below-the-radar wealth, or $12 billion, from the need to hide outside of the banking system. Including both the government's share and what tax offenders get to keep, a fresh $22 billion could potentially get credited into bank accounts.

Something similar happened in 1997. Deposits in the Indian banking system rose by 19 percent and swelled by another 21 percent the next year even though GDP growth slowed because of the Asian financial crisis. For those two years, deposit growth was four times economic expansion, a ratio that hasn't been surpassed since:

How Tax Amnesty Shored Up Bank Deposits
The ratio of bank deposit growth to GDP growth stopped sliding and surged in 1997 and 1998*
Source: Reserve Bank of India, International Monetary Fund, Bloomberg
*Two-year average

A repeat performance could give banks the chance to earn some badly needed profit. After setting aside 25.5 percent for reserve and liquidity requirements, the resulting new cash will be lent out, and ultimately become a deposit at another bank. If the process repeats just twice more, there could be an increase of more than $37 billion in loans. And since India's lenders currently earn a net interest margin of 2.6 percent in aggregate, that could mean about $1 billion in extra earnings.

That isn't all. The fiscal rectitude promised by Jaitley, and made possible by the tax amnesty, has lifted the sagging spirits of the bond market: Any drop in government-note yields would increase their value on banks' balance sheets and give them more trading income. 

Taxpayers will still share most of the burden of making broken Indian banks whole, but those who have skimped on their tax bills will also be lending a helping hand.

This column does not necessarily reflect the opinion of Bloomberg LP and its owners.

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