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Last Updated : Oct 17, 2020 09:47 AM IST | Source: Moneycontrol.com

Banking troubles in old private sector banks

Earlier, the experts wrote that Indian banking is mainly about regulatory activism and near absence of shareholder activism. It is good to see emergence of shareholder activism in most unlikely of organisations: old private sector banks

India’s banking troubles not just keep getting deeper, but also keep shifting from one set of banks to another. We have seen crisis in public sector banks, cooperative banks, New Private Sector Banks (NPSBs), Non-Banking Financial Companies (NBFCs), Housing Finance Companies. With the fiasco in the Lakshmi Vilas Bank (LVB) and in the Dhanlaxmi Bank (DB) soon thereafter, add Old Private Sector Banks (OPSB) to the list. Before discussing this new crisis, let us first review some developments pertaining to the OPSBs.

First, this nomenclature of OPSB is rather odd and India could be one of the few countries whose banks having this nomenclature. When the government nationalised 21 banks (including the State Bank of India) in 1969 and 1980, a few private banks remained. In 1969, there were 50 private banks and by 1991 it declined to 25. The Narasimham Committee proposed opening the banking space for new players leading the Reserve Bank of India to give 10 licences to new banks. These new private banks were termed as NPSBs and the existing ones were classified as OPSBs.

Second, the number of OPSBs currently is at 12 (table below). It is remarkable that youngest of these banks is RBL Bank (erstwhile Ratnakar Bank) which is 77 years old. Three have completed 100 years and six of these, including the LVB and the DB, are in their nineties. They managed to keep their private status despite pressures of nationalisation in 1960s and 1980s, and avoided merger with stronger banks.


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Third, of the 12 banks, nine are based in southern India. This is because of presence of coastal region which provided trading opportunities and led to development of banking. In particular, cities of Karur and Thrissur led to development of six of the 12 banks.

The fourth point is that most of these banks started to serve local communities which were either in trading or agriculture. The Karur Vysya and the LVB was started by Chettiars. The Tamilnad Merchantile Bank was started to serve the Nadar community and was earlier called the Nadar Bank. Likewise, the Catholic Syrian Bank, which shortened its name to CSB Bank, was started to serve Syrian Catholics. The case of the J&K Bank is interesting as it is majorly owned by the J&K government and yet classified as an OPSB. Recently, some of these banks have been facing ownership battles with external investors showing interest in taking control over these banks.

Fifth, the share of the OPSBs in the overall banking sector has been rather timid. The share of the OPSBs in total banking sector assets was around 4.2 percent in 1992 which increased to 7 percent in 1998, and then declined to remain in the range of 4.4-4.5 percent in much of 2000s. The share of the NPSBs in the same period has increased from strength to strength from mere 1.4 percent in 1995 to 27.5 percent in 2019. Despite declining/stagnant share, the OPSB have managed to improve their Net Interest Margin (NIM) from 2.8 percent in 2005 to 3.3 percent in 2019 (the NPSB doubled their NIM in the same period from 1.7 percent to 3.2 percent).

So, what went wrong with the OPSBs?

For this, we should read findings of PJ Nayak Committee report (2014) formed by the RBI to review governance in India’s banks. The committee noted that some of the OPSBs have “attempted to outgrow their historical origins and imitate the NPSBs by bringing in diversified boards and broadbasing senior management.” However, many others have continued on the community path where 'promoter director' controls everything from the CEO to the Board and influences shareholder voting and recruitment of employees.

The committee made two recommendations. First, was for those OPSBs where there are doubts about independence of board members. In such banks, the RBI should mandate that all director appointments be made with the prior approval of the RBI. Second, there are other OPSBs where there are doubts about whether the CEO has any control over the executive management of the bank. In such banks, the RBI “should examine the precise areas of intervention by directors in bank committees and outside of it, and mandate a separation between board oversight and executive autonomy”.

The RBI did act on these suggestions and most of the OPSBs not just have independent directors but also RBI officials serving as additional directors on the Board. However, these steps have not been enough. Apart from governance issues, these banks have also had cases of fraud.

The RBI should have been proactive and addressed governance failure in these banks, but it let shareholders of the LVB and the DB to act. The RBI and its officials have often blamed the PSBs for poor performance in Indian banking. As the PSBs are governed by the Ministry of Finance, the central bank says it cannot do much to improve state of affairs. However, how does one explain poor governance in the NPSBs and the OPSBs which are regulated by the RBI? In fact, Yes Bank as a NPSB was imitating the OPSB as its ‘promoter director’ controlled much of the bank, from management to employees.

There is, however, one positive from these cases: shareholder activism. Earlier, the experts wrote that Indian banking is mainly about regulatory activism and near absence of shareholder activism. It is good to see emergence of shareholder activism in most unlikely of organisations as the OPSBs were seen as under control of promoter director.

It is as if shareholders were responding to Milton Friedman’s highly-referenced article on role of business which completed 50 years in 2020. Friedman wrote that "there is one and only one social responsibility of business — to use its resources and engage in activities designed to increase its profits so long as it stays within the rules of the game, which is to say, engages in open and free competition without deception or fraud." Clearly, some of the OPSBs did not fulfil Friedman’s defined purpose and the good shareholders decided to boot out the top management.

 Amol Agrawal is faculty at Ahmedabad University. Views are personal.
First Published on Oct 17, 2020 08:48 am