Public sector banks have done yeoman service to the country by providing timely long-term finance to infrastructure and core sector projects in the last decade. But, when commodity prices crashed internationally, steel and other projects took a big hit, causing huge problems for them.

Similarly, when roads and other infrastructure projects languished due largely to the widely perceived “policy paralysis” in the UPA government, PSBs suffered. This has resulted in two problems: one, the need for massive doses of capital in PSBs and two, the extra cautious approach adopted by PSB officials while considering further finance for revival requests, made by the affected borrowers.

As for the second problem, the “witch hunting” of officials of PSB unleashed by various agencies such as the Central Vigilance Commission and the CBI is largely responsible. The Centre can resolve both issues by taking some pragmatic steps.

Ways of raising capital Estimates by some rating agencies seem to indicate that by March 2019, PSBs would need additional capital of $90 billion, while the Government might provide about $7 billion. Being the majority shareholder in PSBs, the Government is caught in a bind. While its own financial capacity does not allow it to provide even 51 per cent of the additional capital, the existing political environment would not accept dilution of the Government’s share in PSB capital below 51 per cent. (At present, it is more than 55 per cent in all PSBs.)

The problem could be resolved by any or all of the following methods. One, follow what the legendary investor, Warren Buffett, did when he wanted to attract public money into his company, Berkshire Hathaway, without diluting his control too much. He floated B-class shares having voting rights equivalent to 1/10,000th voting rights of the then existing A-class shares owned by him and his associates. Such differential voting rights are now approved under the present Companies Act. Since the Government owns more than 51 per cent in all PSBs, there should be enough room to get public money with, say, 1/10,000th voting right of existing shares. The B-class shareholders could be vested with the same dividend and other rights as A-class shareholders, excepting the restriction on voting in general meetings.

The second option is to declare one share owned by the Government as a ‘golden share’ with 51 per cent voting rights. This concept had been bandied about in theory but does not seem to have been put into practice. If this route is adopted, the Government can even get money by off-loading its extra shares to the public, instead of pumping additional money into PSBs.

The third option is to raise capital from the public through redeemable cumulative preference shares. These should have a minimum tenure of 15 years to be counted as tier 2 capital. The only hitch could be that according to Reserve Bank of India rules under Basel III, the dividends on these shares are to be treated as interest and debited to the profit and loss account of the bank. This means that although the holder of the shares gets dividends, the amount might not be not tax-free in the hands of the shareholder, even as all other dividends are tax-exempt.

Revamp vigilance system If and when banks float such shares, they would face an insurmountable problem; while the RBI wants the dividend to be ‘interest’, income-tax authorities would treat it as dividend and ask banks to pay tax on profit before preference dividend, and also pay dividend distribution tax. The bank concerned cannot recoup the extra tax in the future by putting it as a deferred tax asset. If the preference dividend does become tax-free, there is bound to be a huge demand from the tax-paying public, who presently flock to tax-free bonds of government companies.

Coming to the over-cautious approach adopted by PSB officials, it is an outcome of the prevailing environment. PSB officials have worked under fear for a long time.

This had been highlighted by the World Bank and an expert committee on banking reforms in 1998. The second (follow-up) committee on banking sector reforms under the chairmanship of M Narasimham, a former governor of the RBI, observed that “the pervasive fear of external vigilance authority has tended to inculcate a ‘fear psychosis’ among bank personnel”. Concluding its views, it said: “The vigilance manual now being used has been designed mainly for use by Government Departments and public sector undertakings. It may be necessary that a separate vigilance manual which captures the special features of banking should be prepared for exercising vigilance supervision over banks.”

Strange practice Indian PSBs would perhaps be the only banks in the world where the lending decisions of its officers are examined well after some years by government officials who might not have granted a single commercial loan in their entire lives.

On that basis, PSBs are asked to initiate “penal action” against an official whose track record may have been otherwise exemplary. The task of thoroughly revising the vigilance manual of PSBs brooks no delay. And the best way of doing this is to entrust it to the recently constituted high power Bank Board Bureau, under the chairmanship of Vinod Rai.

To conclude, a two-pronged approach can make all the difference: additional capital for PSBs can easily be tapped from public without diluting Government majority holding, and the vigilance manual for PSBs should be completely revamped.

Unless these are done, the Centre’s drive for rapid economic growth may run into difficulties.

The writer was deputy managing director of SBI

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