Public sector banks (PSBs) will need between Rs 52,990 crore to Rs 113,550 crore ($7 billion – $15 billion) in recapitalisation going ahead, which can be funded by the government despite the limited fiscal room, suggests a report from BofA Securities. The brokerage suggests the government issues recapitalisation bonds and/or utilise Reserve Bank of India’s (RBI’s) revaluation reserves.

“Our bank analysts estimate that NPLs will likely go up by 2-4 per cent of credit. This will result in a recapitalisation requirement of $7-15 billion for PSU banks. This assumes a 10-11 per cent common equity tier 1 (CET 1) target at 10-12 per cent risk-weighted assets (RWA) growth,” wrote Indranil Sen Gupta, India Economist at BofA Securities in a co-authored report with Aastha Gudwani.

Simply put, RWA is a bank's assets or off-balance-sheet exposure, weighted according to risk. This asset calculation is used in determining the capital requirement or Capital Adequacy Ratio (CAR) for a financial institution.

BofA Securities believes one way to fund the requirement is via recapitalisation bonds. Banks, on their part, can invest the capital received in recapitalisation bonds, which should help them heal their broken balance sheets and meet adequate capital requirements.

“Once growth recovers, the government can gradually convert these recap bonds into normal G-secs and sell them to the market, as happened in the past. That said, we argue that bank recap risks are overdone, like 2016. It is true that the MoF will find it difficult to fiscalise PSU bank recapitalisation of 0.25-0.5 per cent of GDP. We already see 2 per cent of GDP of slippage in the consolidated fiscal deficit due to lower tax collections, a shortfall in divestment and fiscal stimulus,” BofA Securities said.

Another way to go about recapitalisation, BofA said, is the RBI's revaluation reserves of Rs 9.6 trillion -- around 4.3 per cent of gross domestic product (GDP) -- and can be utilised for this purpose in a fiscal deficit-neutral and liquidity-neutral manner.

"The interest cost will impact the Centre's fiscal deficit, although that will also be partly moderated by profit transfers from PSU banks holding recap bonds. Recapitalisation bonds enter the fiscal deficit in the year of their maturity. This is why past recapitalisation bonds were issued without any fixed maturity," BofA Securities suggests.

Meanwhile, PSU banks have seen a bad start to the calendar year 2020, with all stocks in this segment witnessing a sharp fall on year-to-date (YTD) basis. Canara Bank, Bank of Baroda (BoB), Union Bank of India and Bank of India are among the top losers at the bourses that saw their market price dip over 50 per cent YTD, ACE Equity data show.