The government will need to revisit its decision to reduce the budget for capitalisation of public sector banks as the Basel IV clock hour nears and Covid-19 continues to put pressure on the economy.

The Basel IV norms for minimum capital adequacy are due for implementation from January 1, 2023. Inspired by the improvement in banks' profits, the government has reduced the funds for capitalisation of banks from Rs 20,000 crore to Rs 15,000 crore. The step is risk-prone and likely to embarrass the Reserve Bank of India (RBI) as wholesale restructuring of corporate and MSME debt has been done during the year, pushing the stressed assets under the carpet.

The restructured loans have increased due to the various dispensations offered to support businesses. As a result, there could be an escalation of distress in banks as the economic impact plays out. The restructured advances ratio of banks has increased to 1.5% from 0.4% during the last year. The stressed advances ratio went up to 8.5% in September 2021, from 7.9% in September 2020.

Bank capital reflects the value invested in the bank by its owner and investors. It is the sum of the bank's assets minus the sum of the bank's liabilities or equal to the bank's equity. Capital adequacy ratio (CAR) is a bank's capital ratio to its risk-weighted assets and current liabilities. RBI monitors this to ensure credit discipline to protect depositors and promote stability in the financial system. Banks must possess adequate capital reserves to handle losses before being at risk of becoming insolvent. A bank with a high CAR is safe to meet its financial obligations. Banks take risks and suffer losses if the risks materialise. Banks have to absorb losses and keep going in challenging times using capital to stay safe and protect people's deposits.

The Basel IV standards are changes to global bank capital requirements agreed in 2017 and are due for implementation in January 2023. The norms include new credit risk and operational risk standards and a credit valuation adjustment. It also consists of an output floor, revisions to the definition of the leverage ratio, and the application of the leverage ratio to global systemically important banks.

The purpose of Basel IV is to level the playing field and harmonise how banks calculate risks, not to increase the level of capital in banks on a global level. That means finding an additional 52 billion EUR of money for the European banking system, based on current lending volumes. 

On 6 July 2021, the Basel Committee for Banking Supervision (BCBS) report found that higher-quality capital and liquidity levels required by the reforms helped banks absorb the shock's impact.

The banking system would have found itself under much greater stress were it not for the lessons learned and, crucially, acted upon in the aftermath of the 2008 financial crisis. There has been a broad consensus from regulators and bankers about the value of the measures implemented so far. However, with the deferred 1 January 2023 date approaching, banks must now move forward with Basel IV. Regulators are sticking to their guns on the need to complete the final reforms. Implementation has been deferred once due to the pandemic and must not be delayed further to prevent shocks.

To coordinate banking regulations across the globe, the Basel Accord enjoins banks to maintain 8% capital through a set of agreements that focus on the risks to banks. The RBI emphasizes that public sector banks should keep a CAR of 12%. With higher capitalisation, banks can better withstand episodes of financial stress in the economy.

The government states that it has infused Rs 3,10,997 crore to recapitalise banks during the last five financial years, i.e., from 2016-17 to 2020-21. While Rs 34,997 crore was sourced through budgetary allocation, Rs 2,76,000 crore was through issuance of recapitalisation bonds to these banks.

The government maintains that out of Rs 20,000 crore provided last fiscal, three banks - UCO Bank, Indian Overseas Bank and Central Bank of India - availed only Rs 11,500 crore. In FY2021, average capital to risk asset ratio for banks improved from 12.11% to 14.57% because of the improved profitability of banks.

The banks' gross bad loans have declined to a little over Rs 8 lakh crore by the end of the September 2021 quarter, from over Rs 9.33 lakh crore by the end of March 2019. Of this, the share of public sector banks in bad loans proportion has also declined to 72% against nearly 80%. The sale of 15 accounts worth Rs 50,000 crore before 31 March 2022 to the bad bank (NARCL) might free the bank capital.

Banks, however, have buried prospective non-performing assets (NPAs) for more than Rs 150,000 crore, mainly from the fragile MSME segment. The profits are primarily due to the selective subdued lending during the pandemic-infested time cycle. As such, the decision to reduce the budget for capitalisation of banks is distant from the needs of the evolving situation and requires a revisit of the demands of Basel IV norms.