A new deal for public sector banks?

One of the issues that has worried policymakers and the Reserve Bank of India over the past two years has been the pile-up of bad loans and their effect on bank balance sheets, particularly public sector banks.

On Monday, a story in this newspaper informed us that banks are busy doing something about their burden by selling assets of defaulters to the Asset Reconstruction Company of India (ARCI).

According to the company’s Managing Director and CEO, 2013-14 saw a dramatic rise in asset sales — ₹4,400 crore, from just ₹780 crore the previous fiscal.

The reason for this initiative that cuts across PSBs — from Indian Bank to the SBI — is the central bank’s notice some months ago to banks about taking action on unrecovered loans even before the 90 days grace period after which loans are declared bad.

Now the RBI wants banks to consider the option of asset sale if the borrower has delayed payment on loans by more than a month.

This spurt of action should provide a kind of context to the PJ Nayak panel’s recent report on bank board governance. The panel was constituted by the RBI on January 20. No doubt, the report will be placed before the new finance minister.

It is difficult to guess just how the new government will receive the Nayak recommendations on how PSBs and private banks should be run. The committee finds considerable faults and weaknesses in bank board governance -- faults and constraints that impede the functioning of banks in an era of fierce competition, premium on profitability and high risk.

The starting point for the committee is to identify those constraints on public sector banks which their private counterparts don’t have. “These constraints encompass dual regulation (by the finance ministry, and by the RBI, which goes substantially beyond the discharge of a principal shareholder function)…”

The committee has in mind “the manner of appointment of directors to boards; the short average tenures of Chairmen and Executive Directors; compensation constraints; external vigilance enforcement; and applicability of the Right to Information Act.”

Once these external constraints are removed, avers the Committee, the banks will have the space and atmosphere to tackle the internal constraints and increase competitiveness.

It is interesting that among other things, the committee should list the RTI Act as a deterrent. Look across the spectrum of services Indian citizens are offered and you will find a similar sentiment expressed by bureaucrats and even prestigious higher educational institutions.

This is, of course, an excuse to retain privilege. If banks work well and if civil servants do the same, they should not be afraid of public scrutiny.

At this point, one might think that the Nayak Committee is talking about privatisation. Its concerns, however, seem to lie elsewhere. The need is to design “a radically new governance structure” that will enable banks to raise capital not from the government but elsewhere and help fiscal consolidation.

The objective is to move banks closer to Basel III norms that emerged in 2010 primarily as a result of the financial collapse and the ongoing struggle by banks the world over to find their feet.

So the norms are more stringent, they require higher levels of capital adequacy to deal with future shocks and improve risk management. The deadline has now been extended to 2018 so that banks have adequate time to restructure.

Since the government should not provide financial succour given its deficit, banks will have to find other sources of capital to adjust to Basel III; they also have to internally restructure governance to deal with the other Basel III requirements dealing with capabilities to cope with financial crises.

Of course, Basel III norms have met with criticisms from those who think its regulatory overweight may turn off the spigot for loans.

For instance, the United States Federal Deposit Insurance Corporation would like a more strict leverage ratio than that suggested by Basel III. But the key issue is that regulation is important and that the Nayak committee has recommended a new structure for the purpose.

What it would like is for the government to distance itself from “several bank regulatory functions it discharges.” To do this, it would like the repeal of the Bank Nationalisation Act of 1970 and 1980, SBI Act and that relating to its subsidiaries; all banks should be incorporated under the Companies Act. The government’s holdings should be transferred to a Bank Investment Company (BIC) along with its regulatory functions.

The government’s holdings in PSBs should come down to less than 50 per cent, but it can and will remain the dominant partner. But its regulatory functions will now pass to the BIC.

The key lies in the appointment of boards and senior officials in banks. Right now the finance ministry plays big brother with most appointments of bank chiefs. Under the new dispensation, a Bank Boards Bureau would deal with senior level appointments till the BIC is formed.

Eventually, at the end of a three year process, however, the responsibilities would rest with the boards themselves. As for the RBI, it would continue to assess risk-based assets and do its periodic and random search of the asset quality of banks.

In effect, the new proposals aim at easing the government away from its dominance in regulatory functions and board appointments; that would be passed on to a proposed BIC and eventually to bank boards.

The RBI would continue its vigilance on asset quality.

Will the new administration bite the bullet? The control of banks is also a source of political power. It allows the government through the finance minister to dispense favours and exercise behind-the-curtain authority through the CVC and the CBI.

Which government would like to give that up — even in the name of “development”?