- Government announced an aggressive INR 2.11 lakh crore capital infusion plan for public sector banks reeling under bad loans over a period of two years.
- Bank recapitalisation, as the name suggests, means recapitalising banks with new capital to improve their balance sheet.
- The government, using different instruments, infuses capital into banks undergoing credit crunch.
- Capital is the money invested by shareholders in the business.
- Since the government is the biggest shareholder in public sector banks, the responsibility of infusing capital majorly lies with the government.
- The recapitalisation plan comes into action when banks get caught in a situation where their liabilities are comparatively higher than their assets.
- The liquidity with banks is a liability as it is the money deposited by customers, which needs to be paid sooner or later.
- Due to this their balance-sheet weakens and banks find it difficult to raise capital from the open market.
- The government, which is also the biggest shareholder, can infuse capital in banks by either buying new shares or by issuing bonds.
- The government is currently focused on maintaining its fiscal deficit at 3.2%.
- This means that the government cannot take out money from state coffers and give it to banks. Hence, the government bifurcated the entire INR 2.11 lakh crore amount in two parts.
- A government bond is an instrument to raise money from the market with a promise to pay to repay the face value of the maturity date and a periodic interest.
- A bond issued for the purpose of recapitalisation is called recapitalisation bonds.
- The government will issue recapitalisation bonds, which banks will subscribe and enter it as an investment in their books.
- The banks will lend money to the government for subscribing the bonds. This money raised by the government through these bonds will go back to banks as capital.
- This will immediately strengthen the balance-sheet of the banks and show capital-adequacy.
- Since the government is always solvent, the money lent to the government for subscribing recap bonds is free from becoming a bad loan.