After a challenging last few years, public sector banks (PSBs) finally have some reason to be elated. After lot of deliberations and ideation, the Centre announced a grand recapitalisation plan for the PSBs in October 2017. The announcement was pursuant to the PSBs reporting sizeable losses and, consequently, eroding a large part of their capital over the last two years. Measures taken by the central bank to improve the disclosure around the impaired assets amidst a challenging operating environment had added to the stress.

The recapitalisation of PSBs was driven by the necessity to strengthen the banking system to clean up their balance sheets as the government looks to provide impetus for growth. The Centre has announced bank-wise capital infusion, aggregating to ₹88,800 crore by March 2018, with the weaker banks getting a larger share of the pie and the balance ₹64,900 crore to be provided in the next fiscal. Even though one big problem on capital requirements is being addressed, banks are expected to report weak profitability indicators for Q3 and Q4FY18 as they attempt to clean up their balance sheets with the sharp rise in the bond yields only confounding their woes. Consequently, PSBs are likely to report consolidated loss of ₹30,000-40,000 crore in FY-18 as compared to loss before tax of ₹7,000 crore in FY-17 and ₹22,500 crore in 2016.

Weak link

Following this large recapitalisation programme for PSBs, the Centre should now also focus on improving the governance structure of PSBs, which is perceived by many to be a weak link. This is critical as PSBs would need to reinvent themselves as they strive to remain relevant in a financial landscape, which is undergoing a lot of disruption on the back of technological innovations.

Without compromising on its objectives of financial inclusion and providing funding to the SME segment, the Centre can put in place a structure that may include appointing chief executives with clear upfront mandates on meeting the Centre’s objectives, which could be different for different banks. However, to get the desired results, the Centre should consider a longer tenure for the chief executives, along with operational freedom. Of course, the Centre has the flexibility of implementing such a strategy across all PSBs or only on a select few to begin with. An empowered CEO/board may be in a better position to address the broader aspects of banking.

Bolstered by the capital infusion, we expect banks to become more competitive in both extending credit as well as raising funds. On the lending side, PSBs have ceded market share in advances to the private sector peers and NBFCs over the last two years. Within the banking system, we estimate the share of PSBs to have come down from 78 per cent as on March 2015 to 71 per cent as on September 2017.

Better usage of technology can continue to aid the private sector banks and NBFCs to achieve a better growth over the PSBs. In this scenario, PSBs would do well by first improving their internal credit process, before they binge on credit growth to bridge the market share gap sooner.

Meeting challenges

Deposits have been the bedrock for the banking system’s liabilities. Going forward, we believe banks would incrementally face challenges on the liability side as well, as alternative channels for financial savings such as mutual funds, insurance, national pension system etc gain further traction and savers get comfortable parking more of their surplus in instruments that are tax efficient and provide better returns.

We expect the Centre to maintain the preferential tax treatment for these alternative channels as part of their broader plan to de-risk and reduce the currently high dependence on banking system for the economy. Notwithstanding their pan India franchise, PSBs would need to enhance technology adoption in improving their efficiencies and lower costs to offset any rise in cost of liabilities.

PSBs with a large branch network need to explore avenues to meaningfully deploy the workforce for more productive uses such as portfolio monitoring, recovery and client connects.

The Centre, being the promoter, has once again supported the PSBs with capital infusion. However the quality of any institution depends on how it is able to withstand operating challenges, competition and reduce their dependence on the sponsors. Notwithstanding the structural framework for PSBs, they have scope to improve their financial and business profile, while meeting expectations of various stakeholders.

The writer is Senior Vice-President, Group Head - Financial Sector Ratings, ICRA