X

Sign up for Equitymaster's free daily newsletter, The 5 Minute WrapUp and get access to our latest Multibagger guide (2018 Edition) on picking money-making stocks.

This is an entirely free service. No payments are to be made.


Download Now Subscribe to our free daily e-letter, The 5 Minute WrapUp and get this complimentary report.
We hate spam as much as you do. Check out our Privacy Policy and Terms Of Use.
Wrong prescription for weak banks - Outside View by S.S. TARAPORE

Helping You Build Wealth With Honest Research
Since 1996. Try Now

  • MyStocks

MEMBER'S LOGINX

     
Login Failure
   
     
   
     
 
 
 
(Please do not use this option on a public machine)
 
     
 
 
 
  Sign Up | Forgot Password?  

Wrong prescription for weak banks
Mar 7, 2014

United Bank of India is not an isolated case of failure. India's weak banks have been pushed into lending beyond their means

It is unfortunate that there has been virtually no meaningful restructuring of public sector banks (PSBs) other than the merger of the New Bank of India with the Punjab National Bank. When private sector banks are in trouble, they are merged with PSBs.

Till the 1980s, banking regulatory norms the world over were slack; so too in India. In the initial stages of regulatory tightening, PSBs were just not allowed to show losses and there was massive and conscious cover-up, overtly aided by the Reserve Bank of India (RBI) and the government.

There were two major reforms in the post-1991 period. First, the government moved from 100 per cent ownership of PSBs to a minimum of 51 per cent.

Second, in 1992, with the introduction of capital adequacy, income recognition and provisioning norms, almost all PSBs had gaping holes in their balance sheets. To bolster confidence, the government undertook a massive operation to inject capital in a large number of PSBs. The stronger banks needed proportionately less recapitalisation and as they were progressively able to access the capital market, the share of government fell close to the 51 per cent minimum level.

In contrast, weaker PSBs needed large and repeated doses of recapitalisation and although these banks attempted to access the capital market, the government's share remained very high.

Disciplinary measures

Along with the large recapitalisation, the weaker banks were put through the discipline of narrow banking to slow down their credit growth, refrain from raising high cost deposits and increased investments in government securities. While the average return on funds declined, the average cost of funds also declined. More importantly, fresh non-performing assets (NPAs) declined drastically while earlier NPAs were written off or were partially recovered.

The narrow banking concept was given up prematurely as political economy pressures came to the fore. It was erroneously argued that to ensure an adequate spread between the cost of funds and the return on funds, banks should step up lending.

Furthermore, it was argued that bank officials in weak banks were demotivated as they were not allowed to lend. The upshot was, narrow banking went into disuse and weak banks went into overdrive on lending. The sick ponies were put on steroids and passed off as race horses but the inherently weak stallions reverted to being sick ponies. In retrospect, it is clear the country has paid a heavy price for prematurely giving up the concept of narrow banking.

The United Bank problem

The recent issue with the United Bank of India should not be treated as a one-off case of poor management. It could reflect a deeper malaise as pressures to show better results end up in the concealment of NPAs.

Raising the question as to whether other PSBs are also afflicted by rising NPAs makes bankers and government officials hot under the collar --- yet, these concerns need to be articulated. There is no point arguing that raising issues result in self-fulfilling prophecies and that it is best not to even discuss awkward issues.

Given the staggering losses it incurred and the fact that current and savings bank accounts account for around 40 per cent of its total deposits, the United Bank of India is well suited to benefiting from narrow banking.

The present system is permissive in that the entire system veers towards a uniform growth rate of deposits and credit. If a bank fails to meet the banking regulatory norms, it should just not be allowed to grow. Injecting more government capital into weaker banks results in weakening the PSBs system as a whole.

It would be best if the government refuses to recapitalise weak banks; if maintenance of the regulatory norms is insisted upon, these banks will not be able to grow. Rather than extracting more dividends from banks, the government should merely put back the dividend as capital.

The RBI was a model proprietor of the State Bank of India (SBI). For many years after the nationalisation of the Imperial Bank of India, the RBI advised the SBI to plough back the dividends into a fund for expanding the rural reach. Reviving such policies would strengthen PSBs as stronger banks would grow faster than weaker ones.

Corrective action

About 15 years ago, the recently retired deputy governor Anand Sinha had admirably led the work in the RBI on prompt corrective action (PCA). Unfortunately, the PCA regime, with all its rigours, was not allowed to develop.

It would be better late than never to activate the PCA regime. When a PCA regime is imposed on a bank it should be put in the public domain. If such a regime is implemented at the incipient signs of sickness, the PCA regime need not be harsh.

It is sometimes argued that as India is a democracy we cannot allow banks to die. There is an erroneous perception that banks can lend, lose and live. The divine right of banks to immortality has to be debunked.

During the upswing of the economic cycle, the problems of weak banks get submerged in the euphoria of growth. The art of good regulation or supervision is to locate incipient trouble spots during good times. As the American business magnate Warren Buffett says, "Only when the tide goes out do you discover who's been swimming naked."

Please Note: This article was first published in The Hindu Business Line on March 07, 2014.

This column, Maverick View is authored by Savak Sohrab Tarapore. Mr. Tarapore, is an economist and he runs his own Multi-Language Syndicated Column. Mr. Tarapore's other column, which appears in The Freepress Journal, is titled Common Voice.

Disclaimer:

The views mentioned above are of the author only. Data and charts, if used, in the article have been sourced from available information and have not been authenticated by any statutory authority. The author and Equitymaster do not claim it to be accurate nor accept any responsibility for the same. The views constitute only the opinions and do not constitute any guidelines or recommendation on any course of action to be followed by the reader. Please read the detailed Terms of Use of the web site.

Equitymaster requests your view! Post a comment on "Wrong prescription for weak banks". Click here!

  

More Views on News

BSE Sensex at All Time High; ONGC Among Top Gainers (Market Updates)

Jul 18, 2018 | Updated on Jul 18, 2018

Markets all time high analysis : The bse sensex at all time high; ONGC among top gainers. Find the latest update, special reports and news on all time high gainers of BSE Sensex at equitymaster.com.

BSE Sensex at All Time High; ONGC Among Top Gainers (Market Updates)

Jul 18, 2018 | Updated on Jul 18, 2018

The BSE Sensex has hit an all-time high at 36,748 (up 0.5%) with ONGC among the top gainers.

Two Meetings That Nailed the Idea of Owning Brilliant Smallcaps Without Buying Them (The 5 Minute Wrapup)

Mar 22, 2018

Certain blue chips hold the potential of delivering returns comparable to small-cap stocks. With these stocks, you can get the best of both worlds.

Is Mutual Fund Categorization Affecting Your Portfolio? Review It Now! (Outside View)

Jul 18, 2018

PersonalFN explains why a mutual fund portfolio review is necessary, particularly after the regulator's mutual fund categorisation norms.

A Sense of Melancholy (Vivek Kaul's Diary)

Jul 18, 2018

...

More Views on News

Most Popular

How to Avoid a 90% Loss Suffered by This Super Investor(The 5 Minute Wrapup)

Jul 12, 2018

Blindly following super investors is a dangerous game to play. Here's how you can avoid such mistakes.

The Answer to Your Wealth Worries: Small Caps (Especially Now)(Profit Hunter)

Jul 10, 2018

If you're worried about the markets - you are on the wrong track. This is opportunity - put your wealth-building hat on, instead - Richa shows you how...

The Multiple Problems with the Minimum Support Price (MSP) System(Vivek Kaul's Diary)

Jul 11, 2018

The price signals that MSP sends out, creates its own set of problems.

New Fund Offer - ICICI Prudential Pharma Healthcare and Diagnostics Fund - Should You Invest?(Outside View)

Jul 6, 2018

ICICI AMC launches an open -ended equity fund following Pharma, Healthcare, Diagnostic and allied theme.

When Disappointment Panda is Around. Buy Quality Stock like This!(Chart Of The Day)

Jul 6, 2018

Buy Companies that can fight all kinds of Pandas and Bears in the long run.

More

Small Investments
BIG Returns

Zero To Millions Guide 2018
Get our special report, Zero To Millions
(2018 Edition) Now!
We will never sell or rent your email id.
Please read our Terms

S&P BSE SENSEX


Jul 18, 2018 (Close)

MARKET STATS