The Government Earned 327,000 cr. from Bank BailoutsThe Government Earned 327,000 cr. from Bank Bailouts

We often hear about how the government “bails out” corporate defaulters. Large numbers are thrown about, but the true nature of the game is:

• Companies take loans from public sector banks
• They don’t pay the money back
• This turns into an Non Performing Asset (NPA)
• Then the corporate promoters use their political or other influences, bribes and other mechanisms to “settle” their debt with banks
• The banks lose money and have high NPAs
• RBI requires banks to have a certain amount of capital, so the government infuses capital in them
• The banks lend again, rinse and repeat

For a long time, public sector banks would repeatedly lose money on certain corporate loans, either evergreening them (giving more loans to cover up existing loans, thus, covering up their non performing status) or taking haircuts (losses). When a bank loses money, the losses hit their "capital". The capital of a bank has certain regulatory restrictions, and RBI gets all worried when it goes below 10%, so the banks had to be recapitalized.

When the government puts money into a bank, it takes more shares. Its ownership of that bank increases.

Since 2014, over Rs. 337,000 crore was used to recapitalize banks. And there has been a huge amount of discussion in the economy - that the government effectively bails out corporate defaulters. But for the first time we have a detailed analysis on the impact:

The government has earned a 327,000 cr. profit on the investments they have made. 

Let's explore.

The Bailout Payback: 327,000 crores and counting

Remember, for each bank, the government put in money into the bank and got shares in return. The shares have a current market value. We tabulated the entire value of the investments (since 2014) and the market value of those investments only (not what the government held earlier).

The result: a massive 12% return per annum (IRR) in the 11-12 years since, with a 327,000 cr. unrealized profit in these banks.

Note: some of the banks have been merged into other banks; but we show them all.

It was a bailout, but the government has earned it all back, and then some.

To put this in perspective, India’s fiscal deficit will be 16 Lakh Crore rupees. The current value of the shares allotted as a result of the capital infusions would be around 41% of the country’s fiscal deficit! (If they sold all of them)

How is this calculated? See with Bank of Baroda's Example

How we did this was:

• For each bank go back about 10-11 years
• Check each investment ("bailout") by the government in the bank
• Find out what price the shares were issued at
• Usually this is a rough average price of the few months before the bailout
• Tabulated this across years
• If the bank was merged with another bank, used the merger ratio to see the number of effectively new shares of the merged bank received
• So, for the shares the government got, the current market value based on 1st July 2024's market price.

Here's what it looks like for Bank of Baroda.

Bank of Baroda issued a total of 162 cr. shares, for a total investment of 21,000 cr. across the years.

This is currently valued at Rs. 44,000 cr. The government can sell those extra shares they own for a profit of 23,000 cr.!

Fixing the Banks: Mergers and the Bankruptcy Act

This rise of NPAs eventually led to the set up of the IBC, the Indian Bankruptcy Code. The IBC told defaulting borrowers that:

• we (the banks) will take away your company
• and sell it someone else
• If you defaulted and have a good "asset" (i.e. working company) then someone else might pay us a good chunk of what we lent
• which is what happened: companies like Essar Steel, Bhushan Steel (read our posts) etc were sold to other companies that bid for them.

This spooked a lot of corporate borrowers who then quietly reduced their "defaults" and paid up. In fact, during the bids for Essar Steel, the eventual winner was Arcelor Mittal - but it was disqualified in the process because it owned large stakes in Uttam Galva Steel and KSS Petron, which had defaulted to banks for 7,000 cr. Arcelor Mittal paid up those loans as well, to requalify. Effectively banks got back more from borrowers getting scared of having their companies taken away from them.

Importantly, in many resolutions (like Bhushan Steel), the banks also got equity shares of the company, so they could participate in the recovery going forward.

Also, the public banking sector had to be fixed, which the government did in two ways.

• Bank Mergers: Banks which were performing poorly or were too small were merged with other banks.
• Recapitalisation: The government recapitalised banks and converted the capital into equity shares by diluting existing shareholders.

As a result of these efforts, public sector banks today have stronger balance sheets, which is reflected in the appreciation of their market cap in the stock markets.

In fact every single bank has made the government money with the exception of Dena Bank. Punjab and Sind Bank and the Indian Overseas Bank have especially performed well, giving an XIRR of 40% and 26% to the Government.

The Government issued Bonds to pay for the Bailouts

A small nuance to this is that starting in 2018, the government, instead of outright giving cash, issued non transferable bonds to the bank. Effectively the government said, to the bank:

• buy my bond at (some interest rate) and give me money
• take that money and give me shares (recapitalization)
• but you can't trade or sell these bonds (non-transferable)

The government reinvested cash received from the sale into the banks and will be repaying these bonds till 2037.

Note: Do not try this at home. SEBI will not allow this for anyone other than the government.

The interest being paid on these are mostly in line with the ten year bond yield, except for bonds issued starting late 2020 which were non-interest bearing. The interest, by the way, is paid out every year - about 18,000 cr.

Now: the government pays between 6% to 8% (weighted: 6.62%) but has earned 12% blended. That's a pretty good result, if you ask me. It's such that the bailout has not been a waste of money - it's been, in fact, profitable.

The government owns too much of public sector banks

Should the government sell its stake in the public sector banks? Well, they own too much of them. The government owns more than 75% of banks in many cases. Take the example of the Indian Overseas Bank. After the capital infusion the Government owns 96.38% of all shares!

So even if the government decides to sell off its newly acquired shares, it will still own a large portion of these banks. Much above the statutorily mandated requirement of 51%.

Moreover, SEBI regulations mandate a maximum of 75% promoter ownership in any company. The government currently is above this cap in five banks (Bank of Maharashtra, Central Bank of India, Indian Overseas Bank, Punjab and Sind Bank and the UCO Bank). In fact if the government were to sell their shares in only these banks and bring their holdings to the 75% level, they would make over 67,000 crore rupees in share sales at current market value.

The government can use that just as a disinvestment target. Without the need to sell shares in other public sector companies.

How can the government sell?

The government has a few options to sell shares. Selling shares in the open market for many banks will result in a large drop in the share price, as current prices are being sustained by minimal float (the Government owns a very large part of the banks)

The typical idea is to use an Offer for Sale (OFS): Announce that everyone can bid for the government's shares, typically at a discount, and watch as the price falls dramatically in advance.

Why not use an open-source algorithm to sell?

The government can use an algorithm, built though open-source by a team like the one that developed the Aadhaar technology. This can sell in tiny bits and pieces over a long period of time, thus not impacting the market too much. Over a few years, the government can bring down its stake, slowly.

They can announce what they are selling, but not how much each day, or if any shares will actually be sold at all on any given day. The algo takes care of the rest. At no point should the government’s volume be more than, say, 5% of the total traded volume of the day, for any share. It might take a long time to sell shares, and that’s a better way to do it so it doesn’t disrupt the market.

The Bottom Line: The Government Profited From The Bank Bailouts

Too often we hear of the government being chided for "write offs" of bank loans by corporate entities. But with the bankruptcy code, such write offs have reduced considerably. And then, as the government recapitalised the banks, the shares they got in return have now generated massive profits.

The difference between bank bailouts and farmer loan waivers: farmer loan waivers are sometimes necessary but result in nearly nothing coming back to the government. (Farmers pay no income tax and relatively little GST) Bank bailouts have resulted in profits because the government participates in the recovery and the economic value too. And a 327,000 cr. profit is an eye opener.

Of course, this doesn't mean they should keep bailing out banks. The IBC has reduced the need for bailouts going forward. There are some troubling instances where banks write-off loans (in recent times!) without taking equity in the companies themselves. This is bad - like the government benefited in banks by taking equity while infusing capital, banks should be forced to take equity in companies whose loans they write-off or do "one-time settlements". Plus, to remove top management of banks if there is a need for a bailout, so that the message is clearer.

We should not celebrate bailouts. However, it's important to note that in the case of Indian bank bailouts in the last decade, the government has made a substantial 12% per annum, with a 327,000 cr. profit.