The tone is clearly being set at the top. As owner and single largest shareholder of public sector banks (PSBs), the Central Government is now flexing its muscles to ensure that PSBs optimally use their capital, which is now a scarce resource.

The Finance Ministry has shot off a letter to the chief executives of all PSBs, asking them to “strive hard” to achieve the targeted objectives set out in the MoU signed with the central government in 2011-12.

Banks have been asked to “pull up their socks” during the residual one year period of MOU as achievements so far – under all the parameters of MOU - have been below par, official sources said.

The objective of the Memorandum of Understanding (MoU) — which had operative period of five years — was to improve long term profitability, quality of assets and optimum utilisation of capital.

CAPITAL SAVED IS CAPITAL INFUSED

The Department of Financial Services (DFS) has now suggested five areas through which banks can strengthen their internal processes and generate additional capital savings in the near-to-medium term.

The five areas are capital release through risk weighted assets reduction, deploying more stringent risk-based pricing, strengthening performance management, capacity building of key bank staff and review of all subsidiaries/JVs for the bank.

PSBs have been given three months to identify the opportunity across these areas, design a roadmap and initiate execution, official sources said.

Progress on this front will be an important consideration into decisions on further capital infusion, the finance ministry has said.

This is the first time ever that the finance ministry has taken an initiative to help banks efficiently deploy their existing capital and reduce reliance on external capital infusion from shareholders, sources in the banking industry said.

SUBSIDIARIES/JVs

Banks have been asked to evaluate what its optimal subsidiary portfolio is given its long-term objectives. This should include a strategic assessment of what subsidiaries can the bank consider exiting or reducing its stake in, the Finance Ministry has said.

RISK-BASED PRICING

Banks have now been advised to deploy more stringent risk-based pricing for all new origination and implementing improved scoring model to enable this.

This will help increase the overall return on equity (ROE) of the portfolio and generate internal accruals needed for future capital, the DFS letter said.

“Although risk-based pricing is ideal, issues like competition and the liquidity in the system play a crucial role in deciding on such an approach”, V Kannan, Chairman & Managing Director, Vijaya Bank told Business Line, when asked about risk-based pricing.

So far, there has been practically no risk-based pricing of loans in the banking system, say many bankers.

RWA REDUCTION

The Finance Ministry has suggested banks can reduce their risk weighted assets (RWA) by 10-15 per cent by improving data quality, data clean-up for existing assets, tightening the processes for RWA allocation and its execution.

Most banks did a similar exercise two years back. The same should be reviewed and implemented on a continued basis, the finance ministry has said.

srivats.kr@thehindu.co.in .

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