A spiritual solution to banking problem, the answer is within, not without

Shishir AsthanaMoneycontrol Research

It's raining allegations with Rotomac and Simbhaoli Sugar joining the alleged fraudster list. The political verbal battle has already started adversely affecting banking sector reforms.

A Business Standard report says that the ruling Bharatiya Janata Party and its allies are expected to be close to 100 seats in the Rajya Sabha in April, well short of the halfway mark of 123. Given the acrimonious environment, it is unlikely that the government can rely on Opposition support to get the Bills cleared.

This would impact passing of the Bill needed to pass relevant amendments to the Bank Nationalisation Act (BNA), which will be required to set up a bank-holding company. The holding company concept was first tabled by Finance Minister Arun Jaitley in his 2015-16 Budget speech.

A precursor for setting up the holding company was the Banks Board Bureau (BBB), headed by Vinod Rai. Reports have already emerged talking about the possibility of BBB being dismantled post-Rai's tenure.

With eight state elections scheduled to be held during the year, the political din is unlikely to come down and it means that most of the Bills which require structural changes are unlikely to see the light of the day.

It means the bank holding company, a revolutionary idea, will also be stuck in limbo. Let's look at what the bank holding company would have done to boost the sector.

Apart from being the holding company of government investments in  banks, it would also be responsible for allocating money to banks according to their performance. It was also expected to, with the help of BBB, choose heads of public sector banks. These are not something that cannot be done in the present setup.

The question is, could a bank holding company, had it been in existence,  prevented the current mess? The answer is a clear no.

There are two issues that are plaguing the banking system. First is the problem of bad loans and second is the recently exposed frauds.

The first issue is because of flawed government policy while the second one is on account of human greed.

Unless the government gives up its control over public sector banks, setting up the bank holding company would mean one more layer of bureaucracy. Selecting chairmen of banks and expecting them to tow the government line is an exercise in futility.

A big reason behind public sector banks not reporting toxic assets earlier is that an employee's career is connected to the loan. A non-performing asset is thus avoided as far as possible by ever-greening the account by giving additional loans through another route.

Giving a loan is a business call, which a banker gives after the project has been approved by the external rating agency and the internal research team. It is a business call which is taken taking into account the environment at the time of assessing the project. As external environment changes the prospects of the companies changes. The worst affected are those projects which are under construction and do not have too much room to fight the external environment. No amount of ever-greening such account will revive the project unless the environment improves.

As for human greed, the three different cases of Nirav Modi, Rotomac and Simbhaoli Sugars show that they would not have occurred had there been checks and balances in place.

But why mainly public sector employees fall into the trap of fraudsters and not private sector ones? Salary disparity is the first thing that comes to mind and rightly so. Private sector banks incentivise their employees through better salary packages, bonuses and the most importantly - e-sops (employee stocks). The bank employee knows his wealth unlocking will happen through these esops and knows that he would be deprived of the benefit if a scam rocks the bank.

Jaitley, as expected, shied away from the industry associations' call of privatising banks. Jaitley said that privatising public sector banks was a challenging decision and would involve a very large bipartisan political consensus.

Privatising  public sector banks does not necessarily mean reducing government’s stake. It could be done by giving the public sector banks more leg room. Some of the best banking talents reside in public sector banks who are working with their hands and legs tied. Incentivising them, trusting them and keeping the government away from banks will clean the system faster than any other act or a holding structure.