Government banking stocks are on fire

Punjab National Bank surged as much as 40 per cent in trade today, State Bank of India was up 24 per cent, Canara Bank jumped as much as 28 per cent, Bank of Baroda was up 24 per cent and most other govt banking stocks, big and small alike jumped in trade.

IDBI Bank was the only one that rallied just about 15 per cent today, which is still almost double that bank deposits would give you after one full year. ICICI Bank is a private sector bank and there is no idea why the stock rallied as much as 10 per cent along with the government owned banks.

The recap bonds

The government on Tuesday approved a PSU Banking Recap plans of Rs 2.11 lakh crores, which include recap bonds, market raising and Budgetary support.

The nature of the recap bonds would be determined in due course, the Finance Minister Arun Jailey said at a press conference. The recap bonds would be for a staggering Rs 1.35 lakh crores.

How do the recap bonds help?

Banks are constrained in lending, because of lack of capital, thanks to the huge surge in provisions and the existing norms, which prevent them from doing so.

With fresh capital infusion in the form of capital bonds, the banks would now be able to lend freely, which should augur well for them. Many industry observers believe that a lot of the muck on the bank books have also been cleaned and they are looking much better now, than they were before.

It could be wasted if there is reckless lending

There are many who believe that the money could go down the drain, if there is reckless lending all over again.

This is precisely why the government may have been reluctant to infuse capital into the banks in the last few years. There may have been a thought of course correction before any free capital is announced.

In any case, one will have to wait and watch, to see how the capitalisation works. The rally in PSU banking stocks may continue largely on the back of short covering. Our belief is that there will be profit booking that sets in once the over exuberance dies down.

Why no recap earlier?

The thought may have been whether fresh infusion into banks would really bare fruit. In the past reckless funding has led to huge losses and one cannot be sure whether capital infusion would be put to good use.

The thought may have been to let banks fend for themselves and in the process if they get weaker so be it.

However, slowly they may have been another thought that emerged, that these banks are crucial for the economy and have to be cared for. In fact, 65 to 70 per cent of the lending happens through PSU banks.

Also, lack of capital for banks only meant that economic growth would slow further, in the absence of lending. Little wonder then banks have been recapitalized.