PSU Banks: Cycles and Recapitalisation.

Understanding the impact of government support on public sector banks

2 min readPublished
A public terracotta water station (pyau) in an Indian neighborhood being refilled with a hose while a resident fills their steel bottle.
How do government banks survive bad loans?

When public banks run low on capital, a special rescue plan keeps them running. Let's understand PSU bank cycles.

The story

In 2015, India's banking system was reeling under a massive bad loan crisis. Public sector banks were at the epicentre, with NPAs threatening their very survival. But from this chaos emerged a turnaround story that continues to unfold.

Public sector banks lent aggressively before 2015, creating a massive bad loan problem. The RBI's 2015 Asset Quality Review forced banks to acknowledge these hidden defaults.

The Insolvency and Bankruptcy Code, introduced in 2016, helped recover stuck money from defaulters. Government recapitalisation bonds injected equity into PSU banks without requiring cash outlay.

With clean balance sheets, PSU banks can now focus on lending and profits. However, their cycles are deeply cyclical, making it crucial to avoid buying at peak NPA optimism.

Despite the cleanup, PSU banks still lack moats compared to their private sector peers.

Asset Quality Review (2015).RBI Mandate
Cleaned up bad loans by forcing banks to list hidden defaults, paving the way for recapitalisation.
Analogy

Debt magnifies outcomes

Consider two shopkeepers, one with a significant loan and the other debt-free. In good times, the leveraged shopkeeper prospers, but during downturns, the debt becomes a burden. PSU banks with high leverage face similar challenges.

Why this matters

Understanding PSU bank cycles and the impact of recapitalisation helps you make informed decisions about your investments. By recognising the cyclical nature and the role of government support, you can better navigate the banking sector.

Lock it in

Where people go wrong

  1. Buying PSU banks at peak NPA optimismIgnoring the cyclical nature of NPAs can lead to poor investment decisions.
  2. Confusing cyclical recovery with structural growthPSU bank fortunes can change rapidly with economic cycles.
  3. Ignoring low ROCE versus private peersPrivate banks often have better return ratios due to operational efficiency.
If you only remember three things

  1. PSU banks' NPA ratios have significantly improved since FY2018.

  2. Government recapitalisation has supported PSU bank balance sheets.

  3. Cyclical nature of PSU banks demands cautious investment timing.

Investors often chase PSU banks during recapitalisation headlines, forgetting that debt magnifies both good and bad years.
Shekar
Shekar
Government just announced massive recapitalisation for PSU banks! Buying shares now before they fly!