It is unfortunate that there has been virtually no meaningful restructuring of public sector banks (PSBs) other than the merger of the New Bank of India with the Punjab National Bank. When private sector banks are in trouble, they are merged with PSBs.
Till the 1980s, banking regulatory norms the world over were slack; so too in India. In the initial stages of regulatory tightening, PSBs were just not allowed to show losses and there was massive and conscious cover-up, overtly aided by the Reserve Bank of India (RBI) and the government.
There were two major reforms in the post-1991 period. First, the government moved from 100 per cent ownership of PSBs to a minimum of 51 per cent.
Second, in 1992, with the introduction of capital adequacy, income recognition and provisioning norms, almost all PSBs had gaping holes in their balance sheets. To bolster confidence, the government undertook a massive operation to inject capital in a large number of PSBs. The stronger banks needed proportionately less recapitalisation and as they were progressively able to access the capital market, the share of government fell close to the 51 per cent minimum level.
In contrast, weaker PSBs needed large and repeated doses of recapitalisation and although these banks attempted to access the capital market, the government’s share remained very high.
Disciplinary measures Along with the large recapitalisation, the weaker banks were put through the discipline of narrow banking to slow down their credit growth, refrain from raising high cost deposits and increased investments in government securities. While the average return on funds declined, the average cost of funds also declined. More importantly, fresh non-performing assets (NPAs) declined drastically while earlier NPAs were written off or were partially recovered.
The narrow banking concept was given up prematurely as political economy pressures came to the fore. It was erroneously argued that to ensure an adequate spread between the cost of funds and the return on funds, banks should step up lending.
Furthermore, it was argued that bank officials in weak banks were demotivated as they were not allowed to lend. The upshot was, narrow banking went into disuse and weak banks went into overdrive on lending. The sick ponies were put on steroids and passed off as race horses but the inherently weak stallions reverted to being sick ponies. In retrospect, it is clear the country has paid a heavy price for prematurely giving up the concept of narrow banking.
The United Bank problem The recent issue with the United Bank of India should not be treated as a one-off case of poor management. It could reflect a deeper malaise as pressures to show better results end up in the concealment of NPAs.
Raising the question as to whether other PSBs are also afflicted by rising NPAs makes bankers and government officials hot under the collar --- yet, these concerns need to be articulated. There is no point arguing that raising issues result in self-fulfilling prophecies and that it is best not to even discuss awkward issues. Given the staggering losses it incurred and the fact that current and savings bank accounts account for around 40 per cent of its total deposits, the United Bank of India is well suited to benefiting from narrow banking.
The present system is permissive in that the entire system veers towards a uniform growth rate of deposits and credit. If a bank fails to meet the banking regulatory norms, it should just not be allowed to grow. Injecting more government capital into weaker banks results in weakening the PSBs system as a whole.
It would be best if the government refuses to recapitalise weak banks; if maintenance of the regulatory norms is insisted upon, these banks will not be able to grow. Rather than extracting more dividends from banks, the government should merely put back the dividend as capital.
The RBI was a model proprietor of the State Bank of India (SBI). For many years after the nationalisation of the Imperial Bank of India, the RBI advised the SBI to plough back the dividends into a fund for expanding the rural reach. Reviving such policies would strengthen PSBs as stronger banks would grow faster than weaker ones.
Corrective action About 15 years ago, the recently retired deputy governor Anand Sinha had admirably led the work in the RBI on prompt corrective action (PCA). Unfortunately, the PCA regime, with all its rigours, was not allowed to develop.
It would be better late than never to activate the PCA regime. When a PCA regime is imposed on a bank it should be put in the public domain. If such a regime is implemented at the incipient signs of sickness, the PCA regime need not be harsh.
It is sometimes argued that as India is a democracy we cannot allow banks to die. There is an erroneous perception that banks can lend, lose and live. The divine right of banks to immortality has to be debunked.
During the upswing of the economic cycle, the problems of weak banks get submerged in the euphoria of growth. The art of good regulation or supervision is to locate incipient trouble spots during good times. As the American business magnate Warren Buffett says, “Only when the tide goes out do you discover who’s been swimming naked.”
(The writer is a Mumbai-based economist)