RESTRUCTURING BANKING SYSTEM: The Global ANALYST

Restructuring Public Sector Banks*

M G Warrier

Burdened with burgeoning stressed assets and built-in inefficiency, public sector banks(PSBs) in India are passing through a dark phase in their existence, which neither their owners (GOI) nor other stakeholders including lakhs of employees had ever imagined till last year. They are paying for the gross neglect of warning signals which were there for a long time now.

Former HDFC Chairman Deepak Parekh observed in a recent article that ‘the problems of PSU banks won't be solved unless the government allows talent to come in, new investors to run banks and stops diktats on who to lend to’. The article also appreciated present government’s moves  ‘to wipe out corruption at top levels, make auctions transparent and great strides made in financial inclusion’ and suggested that ‘India needs to fix its infrastructure through faster regulatory approvals, less bureaucracy and increased allocations in social sectors like health and education’. But when they come from specialists, the diagnosis and prescriptions cover only certain dimensions of the problems and in this case although the present ills of India’s banking system and economy are a function of several policy lapses and conscious dodging of uncomfortable decisions the analyses by experts do not go much beyond market capitalisation and indices of stock prices or the impact of capital infusion on budget deficits.

P J Nayak Committee

An omnibus holding company structure for public sector banks (PSBs) to address the capital needs was mooted in 2012 by the then finance minister, now president, Pranab Mukherjee in his Budget speech.
In January 2014, reserve Bank of India appointed a committee under the chairmanship of former Axis Bank Chairman P J Nayak to examine the working of PSBs with focus on strategy, growth, governance and risk management and review regulatory issues, ownership concentration and representation on boards.

The Nayak Committee which submitted its report in April 2014(just before the May 2014 General Elections) made wide-ranging recommendations which can have structural and functional implications on the working of PSBs. Many of the reform measures affecting PSBs now being initiated are follow-up of these recommendations which include:

(i)                GOI equity in PSBs should be brought down to below 50 per cent;

(ii)              Set up a banking Investment Company(BIC) to act as a holding company to which equity held by GOI should be transferred;

(iii)            Governance and regulatory responsibilities of PSBs should be transferred to BIC in due course;

(iv)            RBI and GOI should withdraw their nominees from PSB boards;

(v)              Setting up of a Banking Boards Bureau responsible for top level appointments in PSBs which responsibilities also will go to BIC in due course;

(vi)            Freeing PSBs from CVC and CBI jurisdictions bringing them on par with private sector banks and

(vii)          Changes in recruitment, remuneration and incentive policies.

From media reports, one gets an impression that GOI is in a mood to go ahead with implementation of major recommendations of Nayak Committee. However,

formation of a BIC will take time as legal formalities like repeal of the bank nationalisation Acts of 1970 and 1980, together with the State Bank of India Act and the SBI (Subsidiary Banks) Act and incorporation of
all PSBs under the Companies Act will be processes which will have to be gone through. The Nayak committee estimated 3 years for the entire reforms to take shape. And the count down can start only after the formal decisions are taken at the highest level(GOI and RBI).

This time around, as RBI and GOI are on the same page and political environment also moving towards stability, it would be advantageous for all stakeholders to come to a consensus on the kind of banking structure that will serve India’s growth needs during the coming couple of decades which are crucial in the country’s economic growth history.

Wholesale restructuring and revamp

The need for restructuring and revamp of the banking system was recognised within a decade of nationalisation of major private sector banks. In 1991, the Committee on Financial System (Narasimham Committee) visualised a structure for Indian Banking System with “three or four large banks that could become international in character; eight to ten banks with a network of branches throughout the country engaged in ‘universal banking’; local banks whose operations will be generally confined to a specific region and rural banks (including Regional Rural Banks) whose operations will be confined to the rural areasand whose business would be predominantly engaged in financing of agriculture and allied activities”.

There is no point in arguing now that the overhaul and professionalization of public sector banks (PSBs) should have happened along with bank nationalisation and there should have been regular ‘health checks’ and ongoing corrections. Just as a ‘health check up’ does not change the condition of a person, the re-classification of more loans as NPAs does not alter a bank’s ability to change. The need of the hour is to support banks to recover their dues from borrowers who have the capacity to repay, infuse professionalism in the banks’ working and restore the faith in the banking system. As private sector banks have failed to perform their responsibilities and are not too willing to grow (their share in banking business is less than 30 per cent), privatising the existing public sector banks is no solution. The failure of Global Trust Bank and merger of several private sector banks with PSBs during the four decades that followed bank nationalisation are fresh in our memory.

Considering the emergence of new banks in the private sector like small banks and payment banks and the likely event of new bank licensing becoming an on-tap affair- in the context of the long gap between the last bank licence issued and the issue of a couple of new bank licences last year, RBI is working on procedures and processes necessary to make this happen- restructuring the banking system cannot wait any further. In this context, revisiting the Narasimham Committee recommendations referred to above and evolving a national policy for mergers and closures as also opening of new banks/branches become relevant. At present same categories of banks compete among them in the same pockets for business. The extent of competition necessary for efficient functioning of the system is a matter of policy perception.

The background for bank nationalisation was that the banking sector which is dependent on public deposits and should remain subservient to ‘public interest’. Perhaps, GOI should also consider nationalising private sector banks which are shying away from social banking and are averse to penetrating to rural areas. Allowing some private sector banks to pick and choose clientele can create imbalances in resources mobilisation, outreach and business profiles of banks. The lament by certain quarters about taxpayers’ money being used to ‘bail out’ PSBs need to be discounted to some extent considering the fact that pay-out to government from banks by way of dividend and taxes more than compensate for the outgo on account of capital infusion.

 Cleansing bank balance sheets

RBI seems to be determined to bring more transparency and professionalism in the working of PSBs. However, as problems are deep-rooted, quick-fix solutions cannot work. Remember:

(i)                The first warning came from the present RBI Governor, within months of his arrival at Mint Road. This was not heeded.

(ii)              Poor quality of management in government and public sector is a reality. But, a sell-out is no solution. The need of the hour is an HR-overhaul from Secretary to Section Officer and from Board Room to front desk.

(iii)            Private sector banks have an option to choose clientele which they are exercising. This is evident from their stagnant business share also.

(iv)            Dependence for funds by infrastructure projects which have long gestation periods and the short-term nature of banks’ resources is an issue to be addressed not just from the narrow angle of ‘NPAs’.

Bad Bank, not a good idea

It is in this context, GOI is toying with the idea of setting up an institution to which stressed assets which PSBs are not able to handle in-house can be transferred. The idea of a ‘Bad Bank’ is not good. But, going by past experience, once central government gets fixed on an idea, all stakeholders will support it for different reasons. A new institution is always welcomed by the under-employed retiring/retired bureaucrats, in whose hands the implementation of new ideas land even today. It means a number of new job opportunities, huge resources and a long ‘gestation period’ for accountability to surface.

Dr Raghuram Rajan had, long back, expressed the view that the concept of a good bank and bad bank may not be relevant in India since much of the assets backing the banks’ loans are viable or can be made viable. He dwelt on the subject in some detail while delivering the CK Prahlad memorial lecture last time and argued that given most of the assets are viable, it would make sense for the banks themselves to recover the dues while adding that in cases where loans are not priced appropriately when transferred to the bad bank, it could create issues. Thus, Dr Rajan was in favour of helping the banks clean up their balance sheets, recognising it as their responsibility.

Speaking at CII’s first Banking Summit at Mumbai on February 11, 2016, RBI Governor Dr. Raghuram Rajan observed:

“An alternative approach is to try to put the stressed project back on track rather than simply applying band aids. This may require deep surgery. Existing loans may have to be written down somewhat because of the changed circumstances since they were sanctioned. If loans are written down, the promoter brings in more equity, and other stakeholders like the tariff authorities or the local government chip in, the project may have a strong chance of revival, and the promoter will be incentivized to try his utmost to put it back on track.

But to do deep surgery such as restructuring or writing down loans, the bank has to recognize it has a problem – classify the asset as a Non Performing Asset (NPA). Think therefore of the NPA classification as an anesthetic that allows the bank to perform extensive necessary surgery to set the project back on its feet. If the bank wants to pretend that everything is all right with the loan, it can only apply band aids – for any more drastic action would require NPA classification.

Loan classification is merely good accounting – it reflects what the true value of the loan might be. It is accompanied by provisioning, which ensures the bank sets aside a buffer to absorb likely losses. If the losses do not materialize, the bank can write back provisioning to profits. If the losses do materialize, the bank does not have to suddenly declare a big loss, it can set the losses against the prudential provisions it has made. Thus the bank balance sheet then represents a true and fair picture of the bank’s health, as a bank balance sheet is meant to. Of course, we can postpone the day of reckoning with regulatory forbearance. But unless conditions in the industry improve suddenly and dramatically, the bank balance sheets present a distorted picture of health, and the eventual hole becomes bigger”.

Dr Rajan’s plea makes sense, also because public sector banks(PSBs), which have higher level of stressed assets compared to private sector banks, are big enough to create their own arms for tackling wilful defaulters and where loans become irrecoverable, there may not be much gain from ‘sale’ of portfolios at throwaway prices, just for removing them from banks’ books. What PSBs need is the go ahead from GOI to do their business professionally. There should be clear differentiation between ‘social responsibility’ and banks’ commercial business. When social responsibilities are thrust upon PSBs, they should be compensated by government to the extent of loss by implementing programmes.

At a time when several new players are preparing to enter the banking business, the message that will go out to the public by creating an entity to handle stressed assets alone, at a cost entirely born by the exchequer, can be disastrous to the trust on which the financial sector is dependant for survival.

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*Submitted version of an article published in March 2016 issue of The Global ANALYST