Bank recapitalisation

Also called: Recap bonds, Recapitalisation bonds · Topic: Banking Regulation, NPAs and Financial Stability · NCERT: Beyond NCERT

Meaning

Bank recapitalisation means putting fresh capital (the owners' own money, not borrowed deposits) into banks, mainly public sector banks (PSBs), so that they can meet the minimum capital norms (CRAR). In India, much of this was done through special non-tradable recapitalisation bonds.

• Formula it targets: CRAR = (Bank's own capital ÷ Risk-weighted assets) × 100
• Why it matters: bad loans eat into a bank's capital. When capital falls, a bank cannot safely lend more. Recapitalisation restores that capital so banks can absorb losses and start lending again. It is one of the 4 Rs of the clean-up of India's bad-loan crisis.

Explanation

Why banks need fresh capital

• Capital is the bank's shock absorber. Capital is the money the owners have put into the bank plus the profits the bank has kept.
• Bad loans reduce capital:
• A loan turns into an NPA (Non-Performing Asset: a loan whose interest or instalment is unpaid for more than 90 days) → the bank earns no income from it.
• The bank must set aside a provision (money kept aside from profits to cover a likely loss) → profits fall, or turn into losses.

• Losses are taken out of capital → CRAR falls.

• Low capital stops lending:

• Every new loan adds to risk-weighted assets (loans and investments adjusted for how risky they are).
• If CRAR is already close to the Basel minimum, the bank cannot give new loans.
• Credit growth slows, so investment and GDP growth slow too. This is one half of the twin balance sheet problem.

Worked example (illustrative numbers)

• Start: a bank has capital of Rs 80 crore and risk-weighted assets of Rs 1,000 crore.

• CRAR = 80 ÷ 1,000 × 100 = 8%

• Bad loans hit: the bank sets aside Rs 30 crore as provisions and takes the loss.

• Capital = 80 − 30 = Rs 50 crore

• CRAR = 50 ÷ 1,000 × 100 = 5%. The bank is now under-capitalised and cannot grow its lending.

• Recapitalisation: the government, as owner, puts in Rs 40 crore as equity (shares in the bank).

• Capital = 50 + 40 = Rs 90 crore
• CRAR = 90 ÷ 1,000 × 100 = 9%. The bank can lend again.

How recapitalisation bonds work

• Three steps, all on paper: 1. The government gives special bonds to a PSB. 2. The PSB pays the government cash for these bonds. 3. The government puts the same cash back into the PSB as equity.

• Result for the bank: its capital goes up, and on the asset side it now holds government bonds that earn interest.

• Result for the government: its ownership stake goes up. It pays interest on the bonds every year.
• Non-tradable: banks cannot sell these bonds in the market. This stops banks from turning them back into cash.
• Fiscal effect: the cost did not show up in the headline fiscal deficit (the gap between what the government spends and what it earns, excluding borrowings). Only the yearly interest on the bonds hit the budget.

Sources of fresh capital

• Government infusion: directly from the Budget, or through recap bonds. As the majority owner of PSBs, the government has to do this.
• Market raising: PSBs sell shares to investors.
• Retained profits: a profitable bank builds capital on its own. This is why the recent return to profit matters.

In India

• Background: heavy lending to infrastructure, power, steel and telecom during 2004-2011, followed by stalled projects and the Asset Quality Review (AQR, 2015-16), exposed hidden bad loans.
• PSB GNPA ratio: 4.97% (March 2015) → peak of 14.58% (March 2018) [1].

• Higher provisioning ate into PSB capital, so recapitalisation became necessary.

• Policy frame: recapitalisation is the third R of the government's 4R strategy, followed since 2015: Recognition, Resolution and Recovery, Recapitalisation, Reform [1].

• October 2017 package: Rs 2.11 lakh crore, of which Rs 1.35 lakh crore came through non-tradable recapitalisation bonds.
• Total recapitalisation: Rs 3.12 lakh crore over four financial years [1] (NCERT: about Rs 3.1 lakh crore, FY17-FY21).
• Rs 2.46 lakh crore came from the government.

• Over Rs 0.66 lakh crore was raised by PSBs themselves from the market [1].

• Result on capital: PSB CRAR went from 11.45% (March 2015) to 15.43% (September 2024), a rise of 393 basis points [1].

• Capital came with conditions: the EASE reform index (Enhanced Access and Service Excellence) is a scorecard that tracks how well PSBs carry out governance and service reforms.
• Outcome of the clean-up:
• PSB GNPA ratio 3.12% (September 2024) [1] → 2.30% (September 2025) [2].
• PSBs made their highest-ever net profit of Rs 1.78 lakh crore in FY 2024-25 [2].
• PSBs paid dividends of Rs 34,990 crore in FY 2024-25, of which the government's share was Rs 22,699 crore [2]. So the owner now earns a return on the capital it put in.

Don't confuse with

• Provisioning: the bank sets aside its own profits to cover bad loans. This reduces capital. Recapitalisation adds capital from outside, usually from the owner.
• Bad bank (PARA): the Public Sector Asset Rehabilitation Agency, proposed in the Economic Survey 2016-17, would take bad loans off banks' books. Recapitalisation leaves the bad loans in place and adds capital to absorb them.
• Loan write-off: removes a fully provided bad loan from the balance sheet. The borrower still owes the money. It lowers GNPA but adds no new capital.
• Ordinary government securities (G-secs): these are tradable and raise money for government spending. Recap bonds are non-tradable and are used only to route capital into PSBs.

Prelims Hooks

• Recapitalisation targets CRAR = own capital ÷ risk-weighted assets × 100. A higher CRAR means the bank can absorb more losses.
• 4R strategy (since 2015) = Recognition, Resolution and Recovery, Recapitalisation, Reform [1].
• October 2017 package: Rs 2.11 lakh crore, of which Rs 1.35 lakh crore came through non-tradable recapitalisation bonds.
• Total PSB recapitalisation: Rs 3.12 lakh crore over four financial years, with Rs 2.46 lakh crore from the government and over Rs 0.66 lakh crore raised from the market [1].
• PSB CRAR: 11.45% (March 2015) → 15.43% (September 2024) [1].
• Trap: recap bonds did not raise the headline fiscal deficit by their full value. Only the yearly interest hits the budget.

Mains Points

• Recap bonds, the fiscal trade-off: they saved PSBs without a spike in the headline fiscal deficit.
• But they reduced fiscal transparency, because the real cost was spread over years as interest payments.

• A good answer should weigh quick bank revival against honest public accounts.

• Moral hazard (when someone takes more risk because someone else will bear the loss): if the state keeps bailing out PSBs, banks may keep lending carelessly.

• Capital alone does not fix the causes of bad lending. Governance reform (EASE, the 4R strategy), honest recognition (AQR) and a working IBC are needed alongside it.

• Market raising (over Rs 0.66 lakh crore [1]) and record profits (Rs 1.78 lakh crore in FY 2024-25 [2]) show PSBs can now build capital themselves. This reduces their dependence on the Budget.

• Link to growth: recapitalisation fixed the bank side of the twin balance sheet problem.

• More capital → banks can lend again → private investment can recover.
• GNPA of PSBs fell to 2.30% by September 2025 [2]. This shows the combined effect of recognition, resolution and recapitalisation.

Related concepts

• Twin balance sheet problem
• Evergreening
• Asset Quality Review
• Loan restructuring
• Loan write-off
• One-time settlement
• Wilful defaulter

Read more

• The NPA crisis: twin balance sheets, evergreening and the clean-up