From the Editor: February 15, 2015

Shortly after the global financial collapse triggered off by the sub-prime crisis, financial regulators around the world realised the need to revisit the capital adequacy norms and various other guidelines under which their banks were operating. Till then, the banks around the world generally adhered to the guidelines set by what was called Basel II - or a set of norms of financial requirements that had been agreed upon by the Basel Committee on Banking Supervision, whose members included most of the central banks around the world. In 2010/11, they came up with what are called the Basel III norms. These prescribed fairly stringent norms for the minimum capital a bank was required to maintain, a couple of capital buffers that were mandatory, and finally a leverage ratio that would prevent a bank from becoming overleveraged. And several other requirements.

All commercial banks globally were to become Basel III-compliant by 2015, though the deadline was first extended to 2018 and now 2019. The Reserve Bank of India is also a member of the Basel Committee, and hence all Indian banks need to meet the Basel III capital adequacy norms by 2019. If they cannot meet those norms, the RBI can instruct them not to give any fresh loans until they meet the new capital adequacy norms.

The new norms are not a problem for most of the big private sector banks. ICICI Bank and HDFC Bank even today maintain a capital adequacy ratio that is far in excess of what Basel III prescribes. But for most public sector banks, the new norms represent a big challenge. Over the past few years, the public sector banks have had to deal with the twin problems of increasing non-performing assets (NPAs) and the government's reluctance to give enough money to shore up their capital. As a result, the capital adequacy ratios of most PSU banks have been deteriorating over the past five years.

Between now and 2019, the public sector banks need to raise a humungous Rs 4.60 lakh crore as fresh capital, at least half of which needs to be equity capital. This is proving to be a huge headache for the bank chiefs as their main shareholder, the government, doesn't have the money to pump up their capital to the extent required. One way to raise the required capital would be for the government to reduce its stake and for the banks to raise fresh equity largely through retail investors. The problem is that the equity markets are quite cold to shares of public sector banks. That's because the public sector banks do not have the freedom that their private brethren enjoy to take purely commercial decisions. They are also required to meet some of the other goals of their promoter. That could range from financial inclusion of the very poor to adequate credit for the infrastructure sector. All these make the public sector banks far less attractive to the average investor than the private sector banks.

Senior Editor Anand Adhikari explains the full extent of the problem in our cover story this issue. It is a big problem given that the public sector banks account for two-thirds of the loans and advances in the country and any hiccup in their function can bring the country's economy to a standstill.