public sector banks : The way forward for public sector banks

Regulation and supervision of all banks should be made ownership neutral

public sector banks : A release from the Press Information Bureau on June 24, titled “Public Sector Banks”, had this to say on strengthening PSBs: “Over the last four financial years, the Government of India has taken comprehensive steps under its 4R strategy of recognising NPAs transparently, resolving andcrecovering value from stressed accounts through clean and effective laws and processes, re-capitalising banks, and reforming banks through the PSB reform agenda”.

There seems to be some confusion between the legitimate functions of the sovereign; the owner; the regulator and the board or man agement. Recognising NPAs is a matter for the management and the regulator, namely the Reserve Bank of India (RBI). It is common to banking industry as a whole, and not restricted to the public sector. Legislating clean and effective laws and processes is the legitimate function of the sovereign, but thatis also common to PSBs, cooperative and private sector banks. Indeed, common to financial sector. Recapitalising banks is a legitimate function of owners; and in the case of PSBs, the government is the owner of majority shares but not the only share-holder. Some clarity on the PSB reform as distinct from the eco-system of the banking industry is essential in considering the way forward.

public sector banks

The press release also stated that PSBs have been recapitalised with an amount of ~3.19 trillion during 2014-19. An additional amount of ~70,000 crore towards PSB recapitalisation has been budgeted for 2019-20. Additional infusion of capital may be needed, if the performance of PSBs continues to be as in the past. To meet capital adequacy norms and retain majority ownership, additional capital will be needed if PSBs do well,and expand their business. Either way, there could be demands on fiscal unless policies change in future.

Union finance minister announced on August 30 the merger of 10 PSBs into four. Is size an advantage for pursuing the objectives of public sector banking?

Current realities

After the nationalisation of banks in 1969, banking became synonymous with PSBs. But now, private sector banks have significant presence. Further, PSBs are no longer owned 100 per cent by the government. Shares of PSBs are held by FIIs, domestic entities and individuals. By recapitalising unilaterally, the government has injected capital into PSBs, but the other shareholders have not. Whether the unilateral capital infusion by the government has disproportionately benefited non-government shareholders is unclear.

 

With the recent recapitalisation, the share of government has increased significantly in many banks. Interestingly, the share of domestic private shareholding is miniscule in larger private sector banks. In brief, banking system in India is predominantly government-owned or foreign-owned. Will this persist?

 

The share of PSBs in the outstanding credit of all scheduled commercial banks declined from about 75 per cent in 2011 to about 59 per cent in 2019. While the share of private sector banks almost doubled from about 18 per cent, the share of PSBs in annual credit flow decreased from about 77 percent in 2011-12 to about 20 per cent in 2017-18.

In 2013-14, banks had a share of 54 per cent in the flow of resources to the commercial sector. By 2017-18, it was reduced to 45 per cent and during 2016-17, it was only 35 per cent. The role of the banking sector in meeting the credit requirements of the commercial sector has thus been declining; and within the banking system, the share of PSBs is declining. Will this be reversed?

Approaches and risks

The current approach seems to be that all PSBs should be subjected to reform. The reform consists of recapitalisation, consolidation of banks and improvements in governance. It is possible that the risks arising out of regulation, which is not neutral to ownership will persist, and the share of the private sector banks would continue to increase. Unless government and RBI guidelines on ownership of banks change, the banking systemas a whole will be increasingly dominated by foreign shareholders.

The alternative approach is a call for privatisation of all PSBs on the grounds that such a move will reduce fiscal costs and limit the scope for crony capitalism. The risk is that the common man will be left in the lurch because the level of comfort and trust she has in the private sector is not high. It is possible that the dominant ownership of the banking system as a whole will shift to foreign shareholders unless government policies on foreign investment in banks change.

A third approach, viz., a strategic view of public sector banking could be explored to ensure a well defined minimum share of banking for PSBs. This would require the government to support some PSBs while privatising some others based on purposefully well defined performance indicators. A strategic view should also be a countervailing force to the expanding presence of large industrial houses in the growing non-bank financial intermediation.

 

Strategic presence

 

In brief, disjointed incrementalism in policies relating to PSBs, equating them with banking system, poses risks which can be minimised by some immediate steps. First, make regulation and supervision of all bank (PSBs, cooperatives and private sector) ownership neutral (currently, PSBs and cooperative banks are subjected to dual control by the RBI, Union government and state governments, respectively). Second, the government should set the goal for PSBs to have at least 30-40 per cent of the banking sector’s share, and ensure selective recapitalisation of some banks without ruling out privatisation of others.

 

Third, review the policies relating to fit and proper criteria and ownership of banks with a view to ensuring adequate and appropriate domestic share- holding in all banks. Fourth, ensure that the primary focus of PSBs is social banking with adequate and transparent fiscal support for the purpose.

 

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