Modi Injects Market Medicine Into State Banks Along With Rupees

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This year’s injection of government funds into Indian state-run banks plagued by bad loans comes with a heavy dose of market medicine.

Prime Minister Narendra Modi’s administration will set up a holding company to improve governance of the banks, select top executives based on merit and introduce performance-linked incentives. Former executives of Microsoft Corp. and Citigroup Inc. filled top positions at Bank of Baroda in the overhaul, which Moody’s Investors Service said will improve the credit profile of state lenders and speed decision-making.

Since the Finance Ministry announced the steps on Friday, the average cost of insuring the debt of three state-owned lenders against non-payment dropped 8 basis points from an 11-month high, according to data provider CMA. Stressed assets at government-owned banks have surged to the highest since 2001.

“A stable leadership will be positive for banks’ credit profile,” said Vibha Batra, group head for financial sector ratings in New Delhi at Moody’s local unit ICRA Ltd. “A lot of critical decisions that were on hold in terms of recovery of non-performing assets and balance-sheet growth will happen now.”

‘Right Direction’

Policy makers proposed transferring government’s stakes in the banks to a holding company. The lenders have historically been less capitalized than private peers as mandatory 51 percent state ownership reduces their scope to sell shares. That in turn has restricts their ability to boost lending and forces the government to regularly inject cash.

State Bank of India and Bank of India will be among 13 lenders to receive 200 billion rupees ($3.1 billion) in capital next month. Another 50 billion rupees will be provided later, based on new criteria that will reward more-efficient lenders with extra capital. That makes up the 250 billion rupees Modi has earmarked for recapitalization in the year through March 2016, more than triple the amount added last fiscal year.

“While we believe the capital infusion increase is significant compared to the last few years, it may not be enough to deal with burgeoning impaired loans,” Goldman Sachs Group Inc. wrote in an Aug. 17 report. “The other reform initiatives aiming to improve governance standards are a move in the right direction.”

State-owned banks account for more than 70 percent of India’s outstanding loans. Their stressed assets rose to 13.5 percent of lending as of March 31, the highest level since 2001, central bank data show. The ratio was 4.6 percent for private lenders.

Clear Message

Credit growth has been a missing link in Modi’s efforts to propel growth in Asia’s third-largest economy as stalled projects and an investment slowdown curb demand for funding. Benchmark interest rates in India are among the region’s highest despite three reductions by the central bank this year.

Loans grew 9.4 percent in the 12 months ended July 24, near February’s 8.88 percent, which was the slowest pace since 1994. Advances haven’t exceeded 11 percent since August 2014.

Friday’s statement also outlined the structure of the autonomous so-called Bank Board Bureau that will help lenders with their capital-raising plans.

“The government’s message is clear that performance needs to go up and capital is a ration commodity,” said Ananda Bhoumik, a Mumbai-based senior director at Fitch Ratings Ltd.’s local affiliate India Ratings & Research Pvt. “It’s now up to the new chief executives to deliver. The immediate challenge will be asset quality.”

Measuring Performance

Shares of Bank of Baroda, India’s second-largest lender by assets, surged 15 percent on Monday after Ravi Venkatesan, former chairman of Microsoft’s local unit, was named non-executive chairman. P.S. Jayakumar, who had worked at Citigroup, was named CEO.

Public-sector banks’ performance will be measured based on indicators such as efficiency of capital use and management of non-performing assets, the ministry’s statement showed. The aim is to improve productivity to match private-sector peers, according to IDBI Federal Life Insurance Co.

Indian bankers are awaiting a national code that will incorporate laws for resolving bankruptcies, including recovering debts from companies that go bust. Finance Minister Arun Jaitley said Tuesday that the government will complete framing bankruptcy rules and unveil them “anytime soon.”

“There was a need to take some policy decisions to manage bad loans,” said Aneesh Srivastava, Mumbai-based chief investment officer at IDBI Federal. “Performance-linked incentives were distinctively missing at banks.”