India - Banking Sector Support Loan for $2 billion

September 22, 2009: India’s banks, especially the public sector banks (PSB), have played a vital role in supporting the country’s recent economic performance. They have maintained high levels of credit growth, good credit quality and levels of profitability comparable to private banks in India and the world. They have also promoted financial inclusion and provided critical financial inputs and advisory services to the under-served segments of the production and trading sectors of the Indian economy.

However, since the onset of the global economic crisis the availability of credit has contracted worldwide, and private and foreign banks have reduced the growth of their lending. To prevent the shortfall of capital from affecting India’s economy, PSB have stepped in to maintain credit expansion. This has helped contain the effects of the global crisis on India, and is preventing the loss of jobs and national competitiveness, and enabling the country to continue its fight against poverty.

India's Government has moved swiftly to counter the adverse effects of the global economic environment through a wide-ranging program of economic stimulus measures. Support to public sector banks is an important component of this program, to ensure that a shortage of capital does not constrain lending (as it has done in several other developed and emerging financial markets). The Government of India estimates that the country’s public sector banks will require an injection of at least $4.8 billion during 2009-11 to maintain credit expansion over the medium term. However, the total amount could vary with a change in financial market conditions and the rate of economic growth.

World Bank Support

At the request of the Government of India, the World Bank is providing a Banking Sector Support Loan to the country for $2 billion. The loan will provide budgetary support to the Government of India, helping it to maintain the country’s broad economic stimulus program by enhancing the capital of some public sector banks. This will not only enable PSB to expand credit in the current year, but will also strengthen them for the phase of economic recovery ahead.

The sum will be provided through a Development Policy Loan (DPL). The DPL of $2 billion will support the Government’s budget for FY 2009-10. A possible second DPL, for about $1 billion, is likely to be provided by June 2010. These loans will help the PSB to:

Q&A on Banking Project

How will this loan to the Indian banking sector be utilized?
The World Bank’s new national-level Banking Sector Support Loan for $2 billion (with a possible follow-up loan next year of about $1 billion) is provided to the Government of India for its budget, to support the broad economic stimulus program. As a key part of this program, the Government, as the majority shareholder, intends to provide some public sector banks with the capital needed by them to continue to lend at close to current levels, especially during the early period of economic recovery in the country between 2010 and 2011.

The expansion of credit in the economy will complement the economic stimulus program. Several public sector banks will now be able to expand credit at the high levels demanded by clients, including those in the under-served segments of the economy. Others require additional capital to support prudent lending, which under different circumstances could be obtained from a combination of their own earnings, injections by their shareholders, or the capital market. Unfortunately, capital markets have been affected by the global financial crisis; moreover, some banks are close to the minimum 51 percent government ownership requirement so, even if capital market funds were available, these banks would not be eligible to access them, requiring capital injections from the Government instead.
Does the loan impose any conditions on public sector banks? Will it require any changes in the structure and funding of these banks?
NO conditions are imposed on public sector banks. This is NOT a loan for the recapitalization of banks; it provides budgetary support to the Government of India. As with all Development Policy Lending (DPL), support to the borrower (in this case the Government of India) is predicated upon the maintenance of an appropriate macroeconomic framework, and an effective medium-term strategy for economic growth and poverty reduction. Moreover, as this operation is designed to support the government budget, it is also predicated upon the maintenance of satisfactory public financial management practices. This is no different from the prerequisites of DPL in other countries.

The Government of India has signaled that it intends to provide capital to some public sector banks to enable them to expand credit to support growth and financial inclusion. This action is framed by India’s medium term banking strategy, as well as actions taken since last year to address the effects of the global financial crisis on India. The World Bank considers these actions to be appropriate for the current circumstances, and that they provide a suitable platform for enabling banks to support the country’s economic objectives effectively.
What is a national DPL, and why is this project in the form of a DPL?
A DPL provides budgetary support and is quick-disbursing in nature, supporting a program of completed or proposed economic measures in a country. It can support nationwide measures, or those limited to a specific sector (e.g., vocational education) or specific States (e.g., Bihar). The Government’s economic stimulus measures fall into the first category, as do its proposed actions with respect to providing capital support to public sector banks.
Which banks will be capitalized under this project?
The Government has prescribed a capital adequacy ratio of at least 12 percent for the public sector banks (which is 3 points above the mandatory Basel 2 guidelines adopted by the authorities), together with a targeted overall increase in credit from the public sector banks as a whole of about 20 percent during 2009-2010.

For individual banks, their retained earnings, relative ability to raise funds in the equity market, growth plans, existing head room with regard to other capital sources, and how close they are to the minimum government ownership threshold of 51 percent will determine the timing and size of capital injections from the government budget. Therefore, the list of banks requiring capital support will change over time, depending on dynamic internal and external factors.

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Banking Sector Support Loan for $2 billion