Retaining public character of PSBs key but with an eye on governance: Experts

To answer all the above questions, CNBC-TV18 spoke to Ashima Goyal, Member of Prime Minister's Economic Advisory Council; Bimal Jalan, Former Governor of The Reserve Bank of India; Samiran Chakraborty, Cheif Economist At Citi Bank India and Rakesh Mohan, Former Deputy Governor of the RBI.

Experts are of the view that we may have to retain the public character of public sector banks but have to improve governance issues.

Jalan said the sentiment has suddenly turned positive post the announcement of recapitalization. So the move is positive under the current circumstances where all factors of production are positive like inflation is low, foreign exchange reserve are high, trade sentiment is good etc.

Goyal said it is true that sentiments are positive but the credit may have to wait because it is not that banks lack funds – supply is there but demand is low. Demand will also pick up but will take time.

According to Chakraborty just because of recapitalization plan he does not see an acceleration in growth in the current quarter. The government will give a detailed guidelines on recap bonds and so in Q4 there could be frontloaded large amount recap.

Below is the verbatim transcript of the interview.

Q: Do you think that because of this capitalisation, we are going to get a substantial jump in growth? Was lack of capital the big roadblock and with that removed, we are going to get good growth?

Jalan: Naturally, but the sentiment had become very positive, as you can see. Earlier, if you go back on week ago, the sentiment was not this positive. There were two views whether it will work, it will not work, how are we going, is this is a cyclical move or a structural problem that we are seeing in our economy with the growth rate being low and inflation being low despite the fact that we had high foreign exchange reserves and so on and so forth.

And the corporate sector was waiting. The public sector had high losses, high non-performing assets (NPA) and so on. So all this is a past now, so far as we are concerned. So this is a very positive move and recapitalisation of this magnitude has not been done before. There was a recapitalisation in 1990s for example, but this is a very positive move in my view under the circumstances because all our factors for production are positive, inflation is low, foreign exchange reserves are high, our trade sentiment is very good, we can export, export demand is high and technology of course, we are among the best in the technological power that we have. So all the factors of production are very positive for us.

So the move that has been made in terms of recapitalisation, it has a very positive impact on what you might say the prospects of the economy to my mind.

Q: Would you agree? If you looked at the disruption in the GST and some hangover of the demonetisation problems as well, are we really in a position to take advantage of this surplus credit right away or do you think we will have to wait a couple of quarters?

Goyal: I think we will have to wait. It is true that sentiments are very positive, but market sentiments, the stock markets are always doing well. But we have had – private investment has been low, domestic demand has been low, credit growth has been low and if you talk to bankers then the constraint is not really the supply of funds. They are holding excess statutory liquidity ratio (SLR) just now. The constraint is really lack of demand for funds. And you will not see that turning around that quickly.

But that said, there are a number of factors that suggest that demand will also pick up because consumption had received a temporary negative shock from demonetisation and GST which may be behind us now and the world growth is looking up, that should favourable for our export growth. The government large planned investment will crowd in private investment, but that is going to take some time because that will not be immediate.

One very positive feature is if this recap of banks is tied to giving more credit for smaller enterprises, giving it faster and evaluating the risks properly using data because demonetisation, etc. has made more data available. That is where employment and therefore demand could rise.

Q: Is growth evident for you in the second and the third quarter itself or third quarter for that matter because now, banks should be able to lend right away?

Chakraborty: We have to be realistic on the timelines here. The government has said that by December they will come up with the exact guidelines on the recap bonds and then probably in Q4 we are going to see a front loaded large amount of recap. So till that point of time, the economy should be growing at a pace which we were anticipating before the plan. I do not see an acceleration in this quarter just because of the plan being announced.

Having said that, the way I am looking at it is that is there a problem of demand for credit versus a problem of supply of credit and we never knew the answer. Now we will come to know the answer because at least one part of the puzzle which is the supply of credit, at least that part is going to be taken care of through this recapitalisation plan. And since the private sector banks credit growth was much higher than the public sector banks before this announcement, one can presume that there was some latent demand which these private sector banks were servicing. So now, if the public sector banks, because of better capital comes in there, then it could affect credit growth.

The other part is that in which segment of the economy this credit growth is going to happen. Is it going to be more infra kind of credit growth or is it going to be more retail, SME kind of credit growth because that will have a differential impact on the supply side versus the demand side from an aggregate perspective. If it is increasing the capacity, then it should have a better consequence. We will have to see where it goes.

Q: Do you think the government could say that we are giving you all this capital and we want you to concentrate on MSMEs or SMEs? If they did that, could this be counterproductive, I mean more bad loans because I do not think PSUs as yet, have the data or the analytics capability?

Chakraborty: It is tough to say given that we do not have any details on this programme. In fact, we do not even have even more basic details like which is going to be the issuing agency, is it going to be marketable versus non-marketable, what kind of SLR treatment, repo treatment of these bonds will happen. So there are lots of these questions in the market which are yet to be understood properly. So at this moment, it is tough to say whether this will be some kind of a tied scheme or not, but it is also true that MSMEs are a big driver of the economy. And if you look at the credit growth through this segment that has been quite weak in the recent past. So it is not necessarily a bad idea to stem that.

Q: Do PSUs have the wherewithal to sift and give credit to the right guy on the right parameters. I know some of the NBFCs have developed some bit of a database on it, but public sector banks for the last several years have become wholesale even in their liabilities and they had to be weaned away from it. So do you think if they are directed, would that be a good idea?

Chakraborty: Let me make it very clear that the recapitalisation plan cannot address. We have to keep in mind that recapitalisation is not the solution to all the problems of public sector banks. It does not necessarily increase the efficiency of the public sector banks in any way. But at the same time, it is also true that if you take out the last few years, for a pretty long period, we were funding MSMEs through public sector banks only. So, that model can come back into play if it done properly.

Q: Just your growth numbers? What are you expecting this year in terms of growth value added (GVA)?

Chakraborty: We were looking at around a 7 percent GVA number for the full year which I know is a little bit on the higher side because we think that last year's Q3, Q4 numbers would probably be revised down and that would give a nice base effect for this year's Q3-Q4 to be seen as much higher.

Q: If this recap were to come the way it is, Rs 2.11 lakh crore, it is quite possible that at least Rs 1 lakh crore is going to be growth capital. Now in the hands of banks, it actually gets a multiple of 10. So we are staring at a fairly sharp rise in credit if indeed it is put to use. Are we doing too much too soon? Should the RBI have to keep a hawk eye on inflation next year?

Goyal: I think that the government's push for example is on the supply side, infrastructure, etc. and there are other reforms in agriculture which are keeping food prices, good monsoon, etc. moderate. The rise in prices is also moderate, the procurement prices. So as long as all these factors play out, we are seeing that prices have been low for a long time now.

But somehow we do not want to believe this. The RBI for example is convinced that it will rise. I am not so clear that it will. I think many of our prices indices have been revised downwards for example. So, there are a lot of things happening there. We are not even measuring properly. So it should be data driven. RBI's past few inflation forecasts have all been biased upwards. So I do not think we should be so quick to assume that inflation will rise and we should wait to see if it does. And as long as food inflation is contained, I think we will be okay.

And one point I had about these public sector banks and this huge amount of credit which they can potentially lend, they have been really bitten by this last episode, you know 'once bitten, twice shy' and they are just trying to clone private sector banks now. They are searching for retail lending. They do not want to lend to firms.

But our problem is that credit to firms is absolutely very low rates of growth and you cannot grow without that. And at the same time, various reforms have been undertaken, improvements in governance. I do not think anybody is going to tell them to lend without proper evaluation, assessment of risks, etc. And if they lend to MSMEs  in a big way, it will be very gradually it will scale up. It will not be sudden. So there will be time to build up the fintech.

Q: Your growth number? What is the GVA number you will work with?

Goyal: I think 6.5 rising to 7 by the end of the year. But at present it is not going to be that high. But another positive factor I see is that the RBI has been worried about transmission of interest rates. Now they were not cutting loan rates because of the risk built in from NPAs. Already there has been talk of reducing loan rates which will be a positive for demand, for credit.

Q: Do you think PSU Banks should be given the capital only after some serious governance changes? For instance their boards tend to get dominated by sometimes even party nominees because they come under the Banking Companies Act. Should we first move banks to the Companies Act so that there are at least more safeguards to the board?

Jalan: I have also written about it in the past but this is the most important issue that you have raised in terms of what we might say governance aspects.

The government should decide the policy. What is the policy, how much money we can spend from the Budgetary side, how much money we can spend through the bonds and so on and so forth, that is for the government to decide. It also decides what is the priority of investments in terms of roads or railways or ports or whatever.

However then the governance part on the ground should remain with the governing board of the banks and the governing board of the bank should be judged on the basis of performance and not because they are government banks. You can have the board that you want and you can put one or two of the government representatives on that just as promoters can be on the private sector banks if they want to be on the board of the private sector bank. However if the government keeps an arm's length distance from implementation part, that will be a very positive move. So, I agree with your point.

Q: What is your sense, banks have been capitalised and that is very good but have we really fixed governance? Should we have a UPSC kind of board which will select the board members? Should we do something or move it to Companies Act the entire banking companies?

Mohan: I don't think that movement to Companies Act would make much difference because after all even if they come under the Companies Act, as long as they are public sector banks it will be the government nominating the board members.

Q: The voting percentage at least will be reflecting the shareholder, now even that is not there.

Mohan: Given that the government as long as they remain a public sector bank, the Indian government will always have a majority share. So, I don't think that those things make much difference.

Of course we should not be politicizing the nominees as board members.

Q: How do you depoliticise then?

Mohan: I think we have to face the fact that as long as we do have public sector banks with some rationale for having public sector banks, then these issues will remain. However I would go a little further in the sense that it is really the management of the banks that is much more important as opposed to the board composition.

My own view has been that the problem that took place between 2009 and 2014 or something of that order, may be 2015 perhaps was on government's behest, to public sector banks who were lending particularly for PPP projects. So, the question goes back really to the government as opposed to the banks.

The public sector banks are there because you want public sector banks so that they carry out government policy on certain issues otherwise you don't need public sector banks.

Q: Do you think government should privatise some of the banks?

Jalan: Where there is a public interest involved you should have a public sector bank like a cooperative banks. If public interest is involved you have a public sector bank - building roads, infrastructure - you need a public sector bank because they don't have to depend on the rate of return to provide public services. However you have to choose in saying what is a private interest and what is a public interest. If somebody is doing something which is only a private interest then you can privatise, there is no problem provided there is enough capacity in the private sector to implement that private sector thing.

Q: Are you saying then it is okay for public sector banks not to post profit at all?

Jalan: Remember that they want to make profit, but you may also have keep in mind that the shareholders, the prices of public sector shares would depend on what you are referring to as the profitability and so on. And if the government is the main holder then that does not matter.

Q: My only fear is that a large amount of a capital is going to be given, but we have not taken any tough decision on public sector bank governance. I mean UPSC kind of body selecting their boards or even bringing the stake below 51 percent so that they can laterally recruit and not be under the lens of the Comptroller and auditor general (CAG) and the Central Vigilance Commission (CVC) give, give any SOPs so that the managements are more proactive. Don't we have to take all these hard decisions?

Goyal: I think there has been a move to bring in more market discipline. The idea of reducing government share to 50 percent was to bring in some other shareholders and therefore market discipline. So, that can go a long further, the share could come down more and release they from CAG audits, etc. But there can be a move towards increasing the skill levels in the management towards improving the quality of people you get, getting more independent directors and skilled people on the boards. All that, the Nayak Committee reforms holding company, all these kind, can be undertaken and should be.

But I do not agree with you when you say that there are no reforms. The reason we have had this huge delay in recap, in a way dealing with this problem was it all got aggravated because we started with recognition, regulators forcing them to recognise. Without infusing capital, without doing sufficient reform, those should have come.

Q: Your last thoughts? We are giving a large amount of money and much of it, the interest at least, is coming from tax payers. How do you think we can ensure that public sector banks will not get to 20 percent NPAs yet again?

Mohan: Everybody seems to forget completely that the same public sector banks performed extremely well in the first 10 years of this century that is from around 2000 to 2010 or thereabouts with the same kind of management structure, same kind of governance structures, etc. That is a kind of a question that has to be answered. What was happening then, what happened after that and my understanding is that perhaps there was more government interference, after that period and that is what has to be stopped.

Q: So how do you stop that?

Mohan: That the government has to do itself, restrain itself.

Q: Institutional mechanisms to discipline the government, to ring-fence managements?

Mohan: Once again, as long as the government has majority share, that was done for a long period of time, in the late 1990s, early 2000s, the government had stopped interfering to a great deal and we saw the results.

Q: You do not back privatising some of the banks?

Mohan: No, that is not the issue. Privatisation is not a solution because after all, the biggest private sector banks in United States and Europe with all the very fancy managements, etc. got into a financial crises with the largest amount ever, much more than the Indian public sector banks in 2007-2008.