When the government announced a surprise $32 billion bailout plan for the nation`s state-controlled banks last October, credit rating firms and the nation`s central bank saw it as a huge step to getting the industry back to robust health – and lending more to businesses and consumers.  But their optimism may have been majorly misplaced judging by the latest numbers coming out of the banks. And that may in turn crimp economic growth in Asia`s third-largest economy. 

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Thirteen state banks have reported combined losses of $8.6 billion for the year to March - including $6.5 billion in the last quarter - and their non-performing loans have surged nearly a fifth from end-December levels. Two state banks have reported modest profits and six are still to report.  While many of the banks, including top lender State Bank of India, have said the worst is probably over, they still see one or two more quarters of pain. That means more bad loans getting disclosed and loss provisions shooting up as a central bank order will cause more debt defaulters to be dragged into bankruptcy.

"The government capital is only going to just plug the hole, there is definitely no growth capital," said Udit Kariwala, an analyst at Fitch Ratings` India Ratings & Research. He said smaller state lenders with limited ability to raise capital from the market will have to curtail their lending. 

The 21 state lenders hold two-thirds of India`s banking assets, and accounted for the bulk of the record $150 billion of soured loans in the banking sector last year.

The banks, which have been blamed for indiscriminate lending to sectors such as metals and power that turned sour, can still be held responsible for much of the balance sheet carnage. 

A more than $2 billion fraud at India`s second-biggest state lender, Punjab National Bank, disclosed less than four months ago, not only left a hole but also underlined how weak the banks` grip on risk is. 

Exacerbating the problems is a move in February by the Reserve Bank of India, the nation`s central bank, to withdraw half a dozen loan restructuring schemes that banking experts said were helping banks to avoid disclosing dud loans. It also tightened other rules governing bad loan accounting. 

In addition, the RBI this month banned Dena Bank, a loss-making smaller state-run lender, from making any new loans. Days later, Allahabad Bank, another smaller state-run lender, said it had been asked by the regulator not to increase the number of risky loans and costly deposits on its books due to its capital and leverage position

Bank analysts say more state banks could come under similar restrictions aimed at conserving limited capital. The RBI already has 11 state lenders under its "prompt corrective action" framework that restricts them from expanding.

That is not all. Capital needs will also be exposed by global banking rules fully kicking in by March 2019. They mandate banks to have a minimum core capital ratio of 8 percent, and at least six banks, including PNB are short of that number. 

ELECTION AGENDA
Under New Delhi`s recapitalisation plan - aimed mainly at driving credit growth in an economy where bank loans are the main source of funding for everything from buying a car to building a port - the government has already injected about 880 billion rupees ($13 billion) into 20 banks as of end-March. 

It has 650 billion rupees to inject in the current fiscal year, and the banks themselves were supposed to raise 580 billion rupees through share and asset sales.

Some, including SBI and PNB, last year raised funds from share sales, but several others have postponed such plans. 

Kariwala at India Ratings estimates the banks now need 800 billion to 1 trillion rupees to fund soured-asset provisions and maintain minimum capital ratios alone, which means there will be little left from the bailout for lending growth. 

Some bank analysts say the government may have to increase the size of the bailout. 

Certainly, bank lending - and its impact on growth - will be on Prime Minister Narendra Modi`s agenda ahead of a general election that has to be held within a year. 

"Given how the stocks are doing, the nearly 0.6 trillion rupees banks need to raise looks difficult. So, the government may have to slightly increase the amount they are planning to inject," said Srikanth Vadlamani, vice president of the Financial Institutions Group at Moody`s Investors Service. 

Moody`s said this week that PNB alone would need 120-130 billion rupees of new capital in the year to March to achieve an 8 percent core capital ratio. At the end of the last quarter it was at just 5.95 percent. 

IMPORTERS` FUNDING CHANNEL SHUT
Businesses, especially the smaller ones, are already complaining of not getting the loans they want. In February to March, lending to small businesses dropped 0.2 percent, though overall lending grew 5.9 percent. For importers, a major channel of funding - overseas credit through letters of undertakings from Indian banks - has been shut after the PNB fraud, forcing those businesses to depend more on domestic rupee loans. The Indian government will ensure that all state banks including the weaker ones meet the minimum regulatory capital ratio, said Rajeev Kumar, the top bureaucrat overseeing the banking sector at the finance ministry.

He also said with the planned recapitalisation some of the banks will have room to grow, while bad loan recoveries in the bankruptcy process will further aid banks` bottomlines, He said he expects the banks woes to subside in a quarter or two. "Whenever you do the cleaning part, a bit of dust, a bit of pain, upfront is okay," said Kumar. "It`s only one quarter that you have to just wait."