WEDNESDAY, 25 OCTOBER 2017 1/4

BANK RECAPITALIZATION PLAN

A pro-growth initiative…

Summary:
 The Government has announced a bold initiative to recapitalize Public Sector banks (“PSU Banks”) to the extent of
Rs. 2.11-lakh-crore (Rs. 2.11 trillion). Of this recapitalization plan, recapitalization bonds will account for Rs. 1.35 lakh
crore (Rs. 1.35 trillion), while Rs. 76,000 crore (Rs. 760 bn) will be available to the Banks through budgetary support
and equity issuance.

 Of the second component of Rs. 76,000 cr., Rs. 18, 000 cr. (Rs. 180 bn) will come from the earlier Indradhanush plan
and the balance Rs. 58,000 cr. (Rs. 580 bn) might have to be raised by banks from markets. The recapitalization will
occur over FY18 and FY19, although the government is likely to consider frontloading the program.

 We believe that the recapitalization plan is a pro-growth initiative. While the impact on GDP growth in the near-term
is expected to be neutral, the recap plan will likely help Banks tide over their current issue of weak capital base, and
revive the much desired credit growth through increased lending activity.

 Market sources suggest that the government had carried out similar recapitalization programmes in the 1990’s and
early 2000’s.

How the recapitalization bonds will work:

 To the extent of the recapitalization bond plan corpus, the government will infuse capital into the PSU Banks, which will
go to the Banks’ balance sheet. On the same day, the government will issue the recapitalization bonds of identical
quantum, and the concerned banks will subscribe to the bonds.

 The event should be liquidity neutral for the Banks, as the capital infusion and bond subscription will happen on the
same day.

 If the Banks are allowed to later sell these Bonds in the markets, this will allow banks to expand their loan book, but this
will also increase the supply in the bond market. If the Banks are required to hold these Bonds in their books as
investments, they can earn interest income from the bonds.

 The recapitalization bonds will have non-SLR status.

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Impact on PSU Banks:

 The recapitalization plan is a big initiative and should help meet a significant part of the capital needs of PSU banks
towards growth, credit growth and provisions towards stressed loans.

 The recapitalization plan should enhance the ability of the banks to lend, and aid in the revival of the credit growth.

 The plan should also enhance the recognition and resolution of stressed loans by the Banks.

 With better-capitalized banks, the Government may also potentially consider consolidation in the PSU banking sector.

Impact on fiscal deficit:

 The fiscal impact of the recapitalization may be limited. As per what the Finance Mister has indicated, there is a
possibility that the recap bonds may not be considered a part of the fiscal deficit, at least for now, but may enter the
fiscal deficit in the year of their maturity. However, this assumption is yet to be confirmed, and may depend on the
structure of the issuance.

 However, the debt-to-GDP ratio could increase as and when the Government issues the Bonds.

 Bond interest payments (by the Government to the Banks) will have a small impact on the fiscal deficit.

 It remains to be seen how the rating agencies will view the recap plan, given the Government’s focus on improving the
health of the banking system, resuming credit activity (and therefore, growth) in the economy.

Impact on bond yields:

 Assuming that the recap plan is intended to be cash-flow neutral for the Banks and not considered a part of fiscal deficit,
it should generally not be disruptive for bond markets. With the recap plan in place, no additional government bond
issuance is foreseen, as of now.

 However, bond yields may rise slightly on account of expansion of the government’s total debt and a likely improved
market expectation with respect to growth/inflation emanating from improved supply side dynamics.

Impact on Equity markets:

 The government’s plan to capitalize PSU Banks is a big initiative and should cover most of the shortfall towards
increasing capital requirements and provisions towards stressed loans.

 Over the last few years, Private Banks/NBFCs gained significant market share because of inability of PSU Banks to lend
on account of lack of capital. With this infusion, PSU Banks will get the focus back on credit growth. This will raise
competition in the lending market, especially for better quality corporate loans. This might be a risk for private banks as
well.

 Overall, this move can lead to re-rating of stocks of PSU Banks with strong franchise and large customer base. The
private bank stocks might see a temporary knee-jerk reaction. The NBFCs and particularly the Housing Finance
Companies, which have been significantly re-rated over the last few years, might see some de-rating on account of
expected higher competitive intensity. We have a negative stance on NBFCs.

 Amongst the PSU Banks, we like SBI and BOB, due to 1) largest customer base and reach, 2) much better efficiencies and
underwriting practices, 3) stronger retail franchise and 4) good IT/ digital infrastructure. Amongst the Private Banks, we
continue to like HDFC Bank, Kotak Mahindra Bank, ICICI Bank and Yes Bank (Source: BAML Research, JB Research).
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Conclusion:
 We believe the recap plan is a shot in the arm for PSU Banks, as it will help them address their weak capital base.

 With the recap in place, we expect PSU Banks to enhance lending activity, which could assist growth and, to some extent,
revival of capex.

 Impact on fiscal will likely to be limited.

 There may be slight (negative) impact on bond yields on concerns of rising government debt and a possibility of the
bonds entering the secondary markets at a later stage, if permitted by the Government.

 The recap plan should generally be positive for equity sentiment around the PSU banking sector. This could indirectly be
positive for the rupee.

 We believe that the rate cut cycle is nearing its end, with the possibility of a final rate cut in December 2017. We find
accrual strategy more favorable (over duration strategies).
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