Banks are all over the news this week and here are some things you need to know about them:
Up until recently, the banking sector was not performing well on the stock markets, here’s why:
Indian banks have been facing an increasing problem of bad loans since the past few years. Bad loans are those loans on which interest payments haven’t been made and the loan hasn’t been repaid. These loans become non-performing assets (NPAs) for the banks and its one of the biggest problems they face.
This impacts people’s faith in the banking sector and negatively impacts shares of these banks. If these NPAs increase further, then it becomes a serious problem for the economy.
Suppose Miss Rhea borrows a business loan from a bank. After a few months, Rhea realizes she cannot repay the loan amount because her business is failing due to bad economic conditions.
The bank cannot do much because they know it’s not entirely Rhea’s fault that business conditions aren’t good. After penalties and warnings, the banks finally let Rhea go and seize whatever assets she possesses, but that isn’t enough to recover the loan they had given her.
Just like Rhea, there may be many such borrowers who wouldn’t be able to pay their loans. This means a big loss for banks and they would have to recover the loss in some way or the other.
To recover the loss banks might have to increase interest rates for existing loans and for new loans to others and reduce interest rates on existing and new deposits. Businesses who cannot repay these increased loan rates thus, have to resort to cost-cutting by either firing people, reducing their input, quality etc. In short NPA’s can impact the economy largely.
Its a cycle, and someone needs to step in, to help these banks. That’s where the government and the RBI come into the picture.
To help banks, the Government announced an allocation of Rs. 2.11 lakh crore to Public Sector banks
This allocation of Rs 2.11 lakh crore would happen through a plan called recapitalization over two years to save public sector banks from their current NPA problem.
Recapitalization is just a fancy financial term which means providing money to banks.
But where will the government get this money from?
The government’s recapitalization plan is split into two parts:
A part of the money (Rs 1.35 lakh crore) will be borrowed by the government as a loan from the public. In return, the government will repay the full loan back, with interest, after a period of time. And as proof of the loan, the government issues bonds. So bonds provide a safe, fixed-income investment opportunity to the public.
So when they say the government will issue recapitalization bonds to save PSU banks this is what they mean.
The remaining Rs. 76,000 crore will come from the government’s treasury. The government’s treasury includes capital raised by the government through taxes and other sources.
All this restored investors faith in the banking sector and they started buying shares of public sector banks:
The banking sector in the Indian stock markets, hit a record high the day after the government announced its Rs 2.11 lakh crore recapitalization packages and banking stocks were in high demand due to this move.
If any news relating to NPA’s confuses you comment below and we will break it down for you.