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 or the loan hasn’t been recovered.
These loans become non-performing assets 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 loans 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 possess, 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 lending loans to others and reduce interest rates on deposits. Which means interests rates for other borrowers increase. Businesses who cannot repay these increased loan rates have to then 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:
The Indian government announced that it would allocate Rs 2.11 lakh crore over two years for saving public sector banks from their current NPA problem. This allocation will happen through a plan called as recapitalization.
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 as a loan where government borrows the money from the public with the promise of returning it back with interest on maturity.
This loan in financial terms is referred to as a bond. It is a type of investment which guarantees fixed returns and it is safe because the government issues it.
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 governments 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:
Banking sector in the Indian stock markets hit record highs a day after the government announced its Rs 2.11 lakh crore recapitalization package to strengthen the NPA-hit public sector banks. Banking stocks were in high demand due to this move.
So next time when people say Investors are bullish about the banking sector: They mean investors are interested in buying shares of banks.
So next time someone says NPA’s you know what they are talking about.
If any news relating to NPA’s confuses you comment below and we will break it down for you.