Bank Recapitalisation
Bank recapitalisation refers to the process by which the government or private investors infuse fresh capital into a bank to restore its capital adequacy ratios, enable continued lending, and in the case of Indian public sector banks, address NPA-driven erosion of equity capital.
India's public sector banks (PSBs) entered a prolonged capital stress cycle following the RBI's Asset Quality Review (AQR) of 2015-16, which forced recognition of large-scale hidden NPAs. The resulting provisioning requirements dramatically eroded the capital bases of many PSBs, with some falling close to or below minimum Basel III capital adequacy thresholds.
The government responded with a structured recapitalisation programme. The landmark announcement came in October 2017, when Finance Minister Arun Jaitley announced a Rs 2.11 lakh crore recapitalisation plan for PSBs over two years. This was to be achieved through a combination of budgetary allocations, recapitalisation bonds (recap bonds), and market fund-raising. Recap bonds were a creative fiscal instrument — the government issued bonds to the banks, which in turn invested the proceeds in government securities, resulting in a capital infusion on the banks' balance sheets without immediate cash outflow for the government.
Additional Tier 1 (AT1) bonds are another capital instrument extensively used by Indian banks. These are perpetual bonds — they have no fixed maturity — and can be written down or converted to equity if the bank's Common Equity Tier 1 (CET1) ratio falls below a trigger level (typically 5.5%). AT1 bonds became controversial after the Yes Bank crisis of March 2020, when the RBI-orchestrated resolution plan wrote down Yes Bank's AT1 bonds to zero. This raised significant investor concerns about the risk profile of AT1 instruments and led to SEBI restricting retail investor participation.
Beyond government infusions, PSB recapitalisation has also occurred through follow-on public offers (FPOs) and qualified institutional placements (QIPs). The government has used PSB recapitalisation strategically — often tied to performance conditions — to encourage operational improvements, mergers (such as the consolidation of 27 PSBs into 12 between 2017 and 2020), and governance reforms.
For equity investors in PSBs, capital adequacy is a fundamental constraint on growth. A bank with a thin capital buffer cannot grow its loan book without raising fresh capital, which is dilutive to existing shareholders. Monitoring CET1 ratios, Tier 1 ratios, and the overall Capital to Risk-Weighted Assets Ratio (CRAR) is essential for assessing a PSB's capacity for earnings growth.