Reimagining the future of PSBs: India's brightest minds on catalysing PSU banks
The public sector banks are at the crossroads. While the entire banking sector was stressed by the economic downturn till 2015 and court orders on coal and spectrum, NPAs of private banks are at 4.5 percent of their total loans while that of PSU banks are at 14 percent. The worst private bank NPA ratio is 7.8 percent; the worst PSU bank NPA ratio is 25 percent.
The latest Nirav Modi fraud has also hit PSU banks much more than private banks. So is it a time to reimagine the ownership and management of PSU banks?
In an special series, PSB 2.0 on CNBC-TV18, Bimal Jalan, Former Governor of RBI, and Sanjeev Sanyal, Principal Economic Advisor spoke on whether we need to redesign public sector banks and if yes, how.
Below is the verbatim transcript of the discussion.
Q: Where is the problem, is it poor regulation by auditors and the regulator, is it indifference and lack of motivation in the management of public sector banks, what has gone wrong?
Jalan: Public sector banks are part of government. So, there may be many problems in terms of execution, in the sense that the whole administrative structure in our country is multi-layered and so if you want to do something it requires a lot of permission and lots of movement of the files from one ministry to another ministry to somewhere else.
So, the main issue is in terms of public sector banks being as part of government. Just as in terms of education or in terms of health or in terms of insurance, you want these services to be delivered. Not that public sector banks are not necessary, they are in my view an important instrument to outreach the people. You have private banks, they are very good and we are very proud of them but if you look at the outreach of the private sector banks, they would be much more limited than the outreach of the public sector banks. When we are talking about public sector, take it in a larger context that we are talking about delivery of banking services to the people.
To come back to your main question that what is it that we can do to improve the functioning of the public sector banks, the main issue that we have to grapple with is that public sector banks which are spread all over - decentralisation. I am in favour of decentralisation of the process. Government should decide on policy. Priority sector lending or what the interest rate should be and so on and so forth, that the Reserve Bank of India (RBI) decides, the two combination - the RBI and the government - they would decide what should be the policy, what should be the interest rate, what should be the outreach and so on and so forth. However the governance part, that is how a public sector bank should be run, that must be delegated and decentralised to an autonomous agency.
We have Bank Board Bureau and so on and so forth but I would say that what we need to do is you think of public institutions like UPSC. If you look at UPSC, if you look at the election commission, they are public institutions and they deliver. The largest free and fair elections in human history is delivered by election commission. If you look at all our IAS, administrative system, it is through the UPSC. You ask yourself the question that why is it that we have institutions of this type, we have institutions of CAG type and they function very well because they don't have to report to the ministry. However what they do, they are accountable to the parliament.
So, supposing if you took a look at the public sector banks and you have a banking bureau, you don't need the department of banking per se.
Q: Do we need 70 percent of the banking sector to be dominated by these kind of banks, that is majority government owned banks? Should we look for a legislative change where by the government owns a smaller number of banks and some of them the government allows its stake to fall below 50 percent, so that administrative controls are reduced?
Jalan: I think you have to first concentrate on the functioning of different public sector banks. I am supposing we have setup public sector banks in an area where the amount of business is very small, where the organisation is very difficult to have with top class bankers and so on and so forth, then the best thing to do is to close that bank for example. If something is not functioning, if something is not delivering what you have set it up to do, then close it and give the job to some other bank.
Q: So, you would go to the extent of closing down some of the public sector banks will not be a bad idea?
Jalan: If they are non-functional, if they are making large losses, if the fiscal cost that you are incurring is much larger than the benefit that you are getting from having that particular bank, then you can close it.
Q: I spoke to Montek Singh Ahluwalia on the same topic and he was suggesting that government can have a big voice in the strategy of a bank even if it held for instance 30 percent, is that something that you would recommend?
Jalan: I don't recommend but when you are talking about Montek Ahluwalia, he is a very thoughtful person and there can be different views. What I am trying to emphasize is that the main part that we have to try and tackle is relationship between what you might call ministries of the government and banks of the government.
Q: You don't want the department of banking services, you would rather have something like the UPSC?
Jalan: If you have the department of banking services, the department of banking services would be monitoring the progress of how the government money is being spent. The example of UPSC etc that I gave was that it is not the public sector part of the problem, it is what we are doing with a particular institution and making it function much better than what we are at the moment able to achieve.
Q: What according to you is ailing the current system especially that big fraud of USD 2 billion that is dominating headlines, would you say that this is just a localised failure of checks and audits or would you say that it has been a more larger failure, that the RBI failed in its regulation, that auditors failed, is it a larger systemic problem?
Jalan: This issue has been discussed and it is very distressing what has happened. We have to see exactly why it happened, how do you allow this kind of functioning of a bank over a period of 3-4 years. If there was some abrupt thing then you can say this happened and this was abrupt and we have handled it. However if this particular problem has been prevailing in a public sector bank for a long time then that should be tackled. If the officials and so on have been doing something then the board is responsible or the scrutiny audit etc there should be something which would reveal what is happening. It has nothing to do with public and non-public, it is the governance part as to why did this happen.
Q: Whether it is the UPA or the NDA combinations, political parties have not encouraged, have not even entertained the idea of bringing governments stake below 51 percent in any of the banks. Do you think that this is going to be politically unsaleable?
Jalan: I don't think it is politically unsaleable as long as these are government banks. If you decide supposing to lower the amount of holding, you can do it because it saves the shareholding of government and it has the money but it doesn't resolve the kind of issues that we have been discussing.
Q: If we have to reduce the stake below 49 percent, first of all it cannot be governed by the Banking Companies Act. As Dr PJ Nayak had said we should probably move it to the Companies Act. If one does that then boards can be more independently appointed, they will reflect shareholding, there can be independent board members. Right now under Banking Companies Act, they are government officials who are board members. So, bringing down below 49 percent accompanied by banks moving to the Companies Act can mean complete reconstitution of the board, can mean competitive recruitment, can't it be more than just cosmetic change?
Jalan: These are not inter-related. Supposing you have reduced it to 49 percent but it is upto the government to decide exactly what the governance system would be, it is still the majority holder.
Q: You would still say that a legislative change is needed or would you not?
Jalan: That can also be done, that is not a problem. You introduced Bankruptcy and Insolvency Act for example, that could have been done two years ago or three years ago or today. Today we have the great advantage of having a government in power with a majority. It is not like 1989 to 2014 when we had 9 separate governments with very short tenure and 20 parties getting together and forming a government. Today you have the opportunity to make fundamental reforms and I hope that will happen.
Q: Let me start with the record of PSU banks appears to be getting worse. The NPAs of private banks as of Q3 ended December 31 was 4.5 percent of their total loans while that of PSU banks are at 14 percent. The worst private bank NPA ratio is 7.8, the worst PSU bank NPA ratio is 24 percent. To what would you attribute this rather difficult performance?
Sanyal: This information you provided is well-known and well understood by both the policymakers and the regulator. This is a legacy in many ways of the previous government. We need to separate two issues that are now getting confused. One is the issue of outright fraud, which has been in the newspapers recently and nobody has covered themselves in glory on this. We need to look at the internal controls of the private sector banks. We need to look at the auditing mechanism and finally we also need to relook at the regulation process. All of that needs to be tightened.
Q: I am not trying to make this an non-performing assets (NPA) discussion at all. The reason why I brought up those numbers was only to say that the banking system was the victim of the same economic slowdown, is subject to the same regulation by the Reserve Bank of India (RBI) and whether it is the coal scam or the spectrum decisions, it affected the entire sector but the public sector banks have come out looking worst even in the fraud issue, the public sector banks are coming out looking worse. Now is there something we have to tackle in terms of ownership governance management of public sector banks per se?
Sanyal: I think the issue you are raising is that there is a moral hazard problem at multiple levels. Since you are hinting at it, is there a plan to privatise them in any immediate sense. So let me take that head on. So there is no immediate plan to privatise these banks.
Having said that, it is understood this moral hazard issue that you have raised is a serious one and we need to tackle with it. There needs perhaps to be a wider public debate about this issue and not just about ownership, it is also about how the regulation of these things work and so on.
So I think there needs to be an issue but as things stand, the issue is being handled – whatever we do with these public sector banks, consolidation, differential growth strategies, narrow banking and so on perhaps even in some cases privatising, whatever it is, their current immediate effort is the following, one is to tighten up the regulation supervision of these entities in order to control for all these fraud that you have mentioned. The second issue and I keep emphasizing this is that we have this legacy NPA issue for a long time and we have finally recognised the problem and we are – thanks to this Insolvency and Bankruptcy Code (IBC) process, which you mentioned has been a successful at least so far - we now need to make sure that the last leg of that gets carried through, which mean that we have to pay attention to the auctioning and the resolution process which as I said, is now boiling up. So we are in the last leg of it, we need to nail it down and make it work.
So this is a critical thing afterwards we can get into all these other things. This is an issue that is live and we need to make it work.
Q: I am not at all denying that that problem is being tackled and tackled very well but should we not start a discussion whether a government’s stake needs to be brought down – not privatised – below 50 percent, which will enable these banks to recruit competitively, reduce administrative layers and therefore quick decision-making?
Sanyal: So as I said – if you are asking me should there be a debate about it, absolutely. There should always be a debate about these things, that is how you keep public policy accountable. If there is anybody who is an advocate of feedback based governance then I am it but let me also add here that let me also give you the other side of it, the public sector banks do play many other roles which cannot be measured in purely profitability terms, there are social, inclusion issues, there are issues for example when you did that demonetisation – this is not about whether demonetisation worked or not that is a separate debate but when you want to do something like demonetisation – public sector banks are the key way you carry it out. You want to have Jan-Dhan Yojna and these kind of things, social inclusion things, again public sector comes on board when you want to go into areas where there is no banking and spread banking. So there are some roles that public sector banks do play, which private sector isn’t burdened with.
Q: A small finance banks and microfinance are doing a reasonable jobs in pockets I agree on rural lending. The rule currently also is that for every three branches in a bank sector, every bank, not just public sector even private sector banks have to open a branch in an unbanked area. There are many ways in which the government has proceeded in inclusive therefore, will you advice the government to seriously consider bringing down ownership?
Sanyal: First of all, there are various ways of achieving even if we decide that 70 percent is way too much for the government to own, there are several ways of achieving this, one of them is of course this can happen organically that is the more efficient private sector banks or foreign banks or whoever they are or even non-banking financial companies (NBFCs) for that matter grow faster than these public sector banks, some of them which are under now being the RBI is directly managing them as you may know currently they essentially be restricted to something of narrow banking. So their growth will be restricted and so on. So there can be one way of going about it is organically let one side grows just by virtue of being a profitable efficient etc and this balancing or rebalancing happens. So that is one way of achieving it.
For example, our corporate bond market needs to grow. It has grown but it is still quite very lightweight and here the point is we could seriously begin to think about the frameworks required for it. One obvious one where incidentally the government should begin to pay some attention is to create a much more liquid risk-free yield curve then there will be issue of nationalised and not nationalised. They have for example the old nationalised bank but then you have IDBI which is a government owned but not considered a nationalised bank because it functions under a different act. So there is a variety of many options. So all of these options should be debated and the government should consider them and act on them as things go.
Q: Will IDBI be an experiment for the government?
Sanyal: I am not in a position to comment. My point is a very simply this that there are many options and combinations permutations of things that need to be done and can be done. It is not like only one or the other. There are many shades of grey in this and it is a combination of these that could be looked at.
Q: I brought up IDBI because the government itself – both Arun Jaitley and earlier Jayant Sinha have spoken about IDBI being an experimentation.
Sanyal: I am not in a position to make any announcement of this issue but I am just pointing out to you that there are large options and some combination will be carried out.
Q: Is it at all possible that the government will consider bringing down the stake in any of the public sector banks?
Sanyal: This is, as I said, not something we are looking to do immediately. I think the finance minister had also made a comment to that effect but as I said, a public debate on the matter is always welcome and we are a feedback based government. If and when the public debate throws up various interesting options, they will be considered.
Q: But why the resistance you think that it is the National Democratic Alliance (NDA) formation or the United Progressive Alliance (UPA) formation, there is tremendous resistance to reducing government stake?Sanyal: Two things – one is this the right time to do it when there are much more pressing and immediate issue. Two – even if you want to do it, you have to first clean up the mess and get this train back on the rails before having the wider debate and yes, there needs to be a wider debate perhaps but that debate need not wait while we are cleaning up and getting this system going again.