Sliver Of Hope For Public Sector Banks

Jan 12, 2015

The Pune Conclave of Banks is a watershed in that it points to a paradigm shift for Public Sector Banks (PSBs) and there is a sliver of hope that there could be a vastly improved PSBs system without giving up the fundamental tenets for which these banks were nationalised.

Non-interference by government

Prime Minister Narendra Modi's categorical assurance that the government would eschew from intervention in the operation of PSBs is a major declaration of intent which could signal a new era. A ground reality is that large borrowers wield an unbelievable degree of clout and it remains to be seen as to how this eventually plays out. A crucial issue is how wanton and chronic defaulters are dealt with.

Majority ownership

Political economy ground realities are that governments of different hues are committed to government retaining a minimum of 51 per cent ownership of PSBs. Basel III compliance will require that the PSBs need an additional Rs 2.4 lakh crore of capital, which will, in turn, require massive injection of capital by government in the PSBs. Given multiple demands faced by the government, it would be difficult to find government funds required to be injected into the PSBs.

A number of committees have recommended that the 51 per cent minimum government ownership be given up. Since political economy imperatives do not permit this, it is futile to persist with such recommendations. If there is a rock mountain, there is no point in battering the mountain. What needs to be done is to go round the mountain or to tunnel through the rock.

Using the French experience with their nationalised banks, the present stipulation for Indian PSBs could be amended to define government ownership to 51 per cent holding being defined as direct government holding plus holdings of public sector units (PSUs) in which the government continues to have a majority holding, with the proviso that if in such PSUs, government holding goes below 51 per cent, the government should give an undertaking that the government would step up its direct holding in PSBs.

As a start, the government should undertake an assessment of PSUs holding in PSBs. This would reveal that PSUs hold substantial holdings in PSBs. Illustratively, the Life Insurance Corporation of India (LIC) holds on average 12-15 per cent of equity of PSBs. The LIC holds over 10 per cent in 11 PSBs and for these banks, the 51 per cent rule could be reduced by say one-half of the LIC's holdings in these PSBs. The Reserve Bank of India (RBI) is rightly concerned about the contagion risk faced by LIC. Hence the reduction in government's direct holding in each PSB should be brought down very cautiously. Per contra, the PSUs should have unfettered freedom to reduce their holdings in PSBs if commercial considerations so merit it.

Mergers of PSBs

It is heartening that mergers of PSBs have been put on the backburner. Mergers forced by government would invariably be of strong banks being compelled to take over weak banks, but this puts a heavy burden on the government as it would have to compensate the strong bank. It would be better to consider mergers of strong banks with strong banks, driven by banks boards with the government talking a neutral stand.

Derisking parent banks from subsidiaries

If parent banks are allowed to walk away from the losses of their subsidiaries, it could result in subsidiaries taking undue risks. If such restructuring is permitted, illustratively, the State Bank of India Mutual Fund should not carry the SBI name, but be called, say, "Neptune Mutual Fund". This issue needs very careful reconsideration.

Government injection of capital

The present policy of injecting more capital in weak banks and less capital in strong banks goes against the objective of overall strengthening of the PSB system, as all PSBs would grow at more or less the same pace. Government should, within the 51 per cent majority ownership rule inject into PSBs only the dividend the government receives from individual PSBs.

Such a strategy would gradually reduce the predominance of PSBs, but strengthen the overall PSB system. This would be in accord with the government's avowed dictum that 'government has no business to be in business'. More importantly, this approach would drastically bring down the net burden on the government.

Autonomy and accountability

While there is general talk about increased autonomy for PSBs, a practical solution would be to increase autonomy in individual PSBs as the government's direct share in the capital of individual PSBs falls below 51 per cent. With increased autonomy would follow increased accountability. A dictum which must be borne in mind, to quote the veteran banker Mr. M.G.Bhide, is that 'autonomy is never given it is always earned and taken'.

Please Note: This article was first published in The Freepress Journal on January 12, 2015. Syndicated.