With a whopping $1 trillion funding needed for infrastructure in the next five years, the planning commission has flagged the idea of lowering government equity below 51 per cent in public sector banks to enable them to meet growing credit requirements.

A view is emerging in the commission that there is no harm in reducing government equity in public sector banks up to 31 per cent, a top government official said. But he added that it might not be politically acceptable at the moment.

The huge investment proposed for infrastructure and other organised sectors in the12th five-year plan beginning next year envisaged a larger role for public sector banks, particularly with the country's bond market not yet fully developed.

“If you want to sustain a strong expansion of bank credit, there has to be large bank capital. This can be done only in two ways… either reduce shareholding of government to a minority and still control them or infuse fresh capital,” planning commission deputy chairman Montek Singh Ahluwalia told Financial Chronicle.

“Whichever way one chooses, expansion of capital (in PSU banks) is essential, though not immediately, but over a period of five years,” Ahluwalia said, adding it was important to make sure that the financing structure was capable of delivering the required funds.

Expansion of capital will help PSU banks create opportunity for them to provide ten times more credit. Also, most PSU banks have reached the credit limit to some key sectors like infrastructure.

At least 10 top PSU banks, including State Bank of India, have government stake of less than 60 per cent, restricting headroom for equity dilution. SBI, the country’s top commercial bank, was faced with difficulties in credit expansion. Its rights issue to raise Rs 20,000 crore has been pending for almost two years now. Last year, the government infused capital of nearly Rs 15,000 crore in two tranches in Bank of Baroda, Oriental Bank of Commerce, Andhra Bank, Dena Bank, IDBI Bank and Vijaya Bank, where government holding had come down below 55 per cent.

The government retains over 70 per cent stake in other public sector banks like Central Bank of India, Indian Bank, United Bank of India, Canara Bank and Bank of Maharashtra, leaving it with sufficient leverage to dilute stake. The government is diffident about further capital infusion as it fears fiscal deterioration. With the government committed to containing the fiscal deficit at 4.6 per cent of gross domestic product this financial year and bringing it further down to three per cent in the next three years, the planning commission is not particularly in favour of capital infusion in banks as it would widen the fiscal deficit. Ahluwalia has suggested capital infusion by way of plan expenditure if fiscal deficit was an issue.

In the late 1990s, when the NDA led by Atal Bihari Vajpayee was in power, the then Reserve Bank of India governor Bimal Jalan had suggested that government equity in PSU banks be brought down to 33 per cent. This, however, required amendments to banking laws — the Banking Regulations Act, the Bank Nationalisation Act and the State Bank of India Act.

Subsequently, when the Manmohan Singh-led UPA government came to power, the proposal was abandoned and it was decided that government equity in public sector banks would not be brought down below 51 per cent in order to retain the public sector character of these banks.

When contacted, Jalan said, “Fifty-one per cent (majority stake in PSU banks) is an old mindset.” Bringing government equity to 33 per cent would improve public accountability while retaining government control. Jalan said this would require amendment to existing banking laws. Dilution of government equity in banks could be effected over five years on a case-by-case basis to ensure that they met capital adequacy norms.

Ideally, big expansion in the organised sector, especially infrastructure, should be funded by bonds, ie, through the bond market, but that would take some time, Ahluwalia said. He said while some bankers might argue against immediate expansion of capital, the planning commission was talking about requirements over the next five years leading to 2017, in order to achieve nine per cent GDP growth.

Banks, on their part, have left it to the government to take a call, though most of them admit to the need for additional capital in the coming years both for sustaining a higher credit growth and for meeting Basel 3 norms. The chairman and managing director of Indian Overseas Bank, P Narendra, said, “Any decision to reduce holding below 51 per cent is entirely up to the government. If they want they can do it. Banks don’t need capital immediately since most of us are already Basel 2 compliant.”

At present most banks have a capital to asset ratio of over 12 per cent, both tier one (paid-up equity plus reserves) and tier two (subordinated debt, revaluation reserves, floating provisions).

Accordingly, bankers said, with muted credit growth, capital was hardly a constraint. However, Canara Bank chairman and managing director P Raman said, “Capital requirements will be higher for sustaining high credit growth, though immediately it will not be problem. Even Basel 3 is not a problem now, since the prescribed leveraging ratio will kick in only much later.”

Basel 3 prescribes a leveraging ratio that ties the risk-weighted assets to the bank's capital. This will become mandatory only in 2018. In most banks tier one capital is already over nine per cent. Since only a few Indian banks have exposures in off balance sheet items, bankers said, Basel 3 compliance was unlikely to be a problem. The combined tier one capital of all scheduled commercial banks based on RBI’s estimate was 10.1 per cent or about Rs 3,95,000 crore.