Stop this dithering on banking reforms

Oct 17, 2014

For too long have political forces and vested interests stalled the dilution of government holding in banks

Central to the financial sector reforms would be the restructuring and financing of public sector banks. The Narasimham Committee II on Banking Sector Reforms (1998) concluded that the fisc just could not meet the capital requirements of PSBs.

Accordingly, it recommended that the minimum government holding in PSBs should be reduced from 51 per cent to 33 per cent. It was argued that reducing the government holding to 33 per cent would not mean a loss of control over the social objectives of PSBs, but it would give a breather to these banks to meet minimum capital requirements.

The impasse

Under the NDA regime, Finance Minister Yashwant Sinha made a valiant effort to get this recommendation accepted, but parliamentarians from his own party blocked the move. The Committee on Fuller Capital Account Convertibility (2006) revived the Narasimham Committee recommendation and also recommended that all banks should be registered under the Companies Act but this was not accepted. The UPA governments I and II swore by the 51 per cent minimum government holding and hence there was an impasse.

The Financial Sector Legislative Reforms Commission (2013) recommended a single Indian Financial Sector Code.

The pronouncements of the present BJP government, however, indicate that they would not deviate from the 51 per cent government holding in PSBs. In fact, there is unanimous support, across all political parties, on the 51 per cent minimum rule, which reveals what kind of vested interests operate at the grassroots level.

The Nayak Committee (2014), inter alia , also recommends that the minimum government holding in PSBs should be reduced to below 50 per cent. Although this is a sensible suggestion it is unlikely to muster political support to undertake the necessary legislative changes.

Immediate financing problems

The PSBs, to be Basel III compliant, would need, by March 2019, about Rs. 2.4 lakh crore of Tier I capital. The Government would need to put up a sizeable portion of this amount; this would clearly be beyond the capabilities of the current fisc.

Moreover, under the present system of financing, the weaker the public sector bank, the larger the government injection of capital, and the stronger the public sector bank, the lower the government injection of capital. Under such a system all PSBs more or less grow at the same rate and the system veers towards a weak structure.

Given the policy of not letting any commercial bank die, over the years, failing private sector banks have been merged with public sector banks with a consequential financial drain on the Government. The merger of the New Bank of India (a PSB) with the Punjab National Bank was a disaster for both the Government and PNB.

Again, facetious suggestions have been made that weak PSBs should be allowed to have a minimum government holding below 50 per cent. The pertinent question which arises is who would subscribe to the capital of these banks.

Damage containment policy

Given the constraints, a practical attempt should be made to minimise the damage to the fisc. In this context a combination of a few minor measures could work towards a significant damage containment policy.

1. Redefining government of 51 per cent minimum: The 51 per cent minimum government holding could be defined as government holding plus holdings of such public sector units (PSUs) that continue to have majority government holding, with the proviso that if such PSUs have less than 51 per cent government holding, the government holding in PSBs would be raised pro tanto . This will ease the pressure on the fisc of financing the PSBs.

   Incidentally, in France, when banks were nationalised, they held shares in PSUs and PSUs held shares in banks.

2. Government receipts of dividends to be reinvested in PSBs: The Government should enunciate a policy that whatever dividend it receives from a PSB must be reinvested in that bank.

   This would, admittedly limit the overall growth of the PSB system but it would strengthen the overall PSB system.

In addition, a number of the Nayak Committee recommendations should be implemented. These could,inter alia , include separation of the posts of chairman and managing director (a recommendation of the Ganguly Report a decade ago), empowering the Board to appoint directors and the setting of each bank's salary structure.

Again, the Government should not be trigger-happy in setting out the regulatory system for PSBs - this should be left to the Reserve Bank of India.

While all these measures may not totally resolve the financing problems of public sector banks, they would minimise the burden on the fisc. To sum up, PSBs need to undertake a bootstraps operation.

Please Note: This article was first published in The Hindu Business Line on October 17, 2014.