Planning to inject $11 billion of capital into debt-laden state banks over the next four years, Finance Minister Arun Jaitley on Friday sought parliament's approval to boost budget spending by $4 billion in the current fiscal year.
High levels of non-performing assets in state-run banks have made it hard for the government of Prime Minister Narendra Modi to revive investment or accelerate growth in Asia's third largest economy.
After initial hesitation, Jaitley agreed with a plea by the Reserve Bank of India to provide more capital to banks.
Jaitley plans to provide 250 billion rupees ($3.90 billion) each in the current and next fiscal year, while 200 billion rupees would be provided during 2017/18 and 2018/19, the finance ministry said in a statement.
Having allocated $1.24 billion for the state banks in its February budget, the finance ministry aims to inject an extra $1.9 billion, if parliament approves. Later, it will seek an additional $50 billion rupees for capital infusion into banks.
The country's top six banks - State Bank of India, Bank of Baroda, Punjab National Bank, Bank of India, Canara Bank and IDBI will get $1.6 billion, the ministry said.
That represents 40 percent of the total $4 billion that the government plans to spend this fiscal year, it added.
All banks will get financial support from the government, 20 percent of the fund allocation will be tied to performance.
After the announcement, shares of State Bank of India rose as much as 6.3 percent, while shares of Bank of Baroda were up 5 percent.
Indian state lenders account for more than 70 percent of all outstanding bank loans, and they need support to meet Basel III regulatory requirements.
The finance ministry estimates that banks will have to raise about $17 billion from the market over four years to meet total funding requirements of about $28 billion beyond projected profits.
Junior finance minister Jayant Sinha told reporters the additional capital infusion for the banks would help meet regulatory requirements as well as growth needs. The government could provide more capital to the banks, if needed.
"We have a robust recapitalisation plan in place," he said.
State-run banks have amassed bad loans at a faster pace than their privately owned peers, raising concerns about their ability to meet tougher global regulatory capital requirements.
While there will be relief at the moves to recapitalise India's banks, U.R. Bhatt, managing director at investment firm Dalton Capital in Mumbai, said there would be some disappointment that the capital infusion was not bigger.
"Most of these public sector banks are not even able to grow their balance sheet because of lack of capital... to grow their way out of trouble they need capital," Bhatt said.
This month, credit rating agency Fitch said the capital needs of state-run banks were likely to increase substantially each year until 2018/19.
Last month Morgan Stanley said the government would need to inject $15 billion across all state banks "urgently" to achieve a common equity Tier-1 ratio of around 10 percent.
It was not immediately clear where the extra money would come from. Sinha said higher tax collections and savings from the fall in international crude oil prices put the government in a "comfortable position" to meet its fiscal deficit target.
The government has a budgeted fiscal deficit target of 3.9 percent of gross domestic product this fiscal year. Its original spending target was 17.77 trillion rupees ($277 billion).