Public sector banks - 1: With government keeping the control, who will put in the capital?
A Banker 11 June 2012

The government wants to hold 51% is PSBs and is inflexible about it. It will soon find out the flip side to this, when asked to put in capital to either maintain this stake or force banks to give up growth

The criticality of operational flexibility and functional autonomy for public sector banks (PSBs) in the context of market driven economy, and competitive challenges engendered by growing internationalisation is dealt with incisively in the “Report of the Committee on Banking Sector Reforms 1998” headed by M Narasimham, a former governor of the Reserve bank of India (RBI) and a distinguished economist. (Incidentally an earlier committee called “Committee on Financial System [CFS] 1991” was also headed by M.Narasimham and hence the report of 1998 is often referred to as Narasimham II).

Narasimham II stated that, “No discussion of the structural issues would be complete without referring to the future of organizational pattern of our public sector banks. This is also closely related to the issue of autonomy in their functioning” (para 5.22, Chapter V –underlining added) which is relevant to recapitalization of banks. The committee pointed out that the banks would need at regular intervals capital infusion to leverage on to capture expanding business opportunities and to meet Basel committee stipulations, which the central government’s budget might not be able to provide because of multifarious demands on its resources. Narasimham II therefore concluded that PSBs would have to raise capital from the market which would be beneficial in other respects as well. To quote, “Accessing the market would engender a discipline of its own in terms of performance which would enhance shareholder and enterprise value.” [op.cit.5.29] Holding the view that government’s dominant ownership would not be conducive to raising equity from the market, it recommended dilution of government holding to 33%.

The successive governments—one led by the NDA and the other two led by UPA I&II, however, have assured the Parliament that  the government stake would not be allowed to go down below 51%, which in effect could mean ‘denationalisation’. The implication of this policy assurance is that the government would have to bear increasing burden of capital infusion into PSBs to meet capital adequacy stipulation even as it is constrained by other fiscal considerations. If the government finds this difficult to fulfill, the banks would have to reconcile themselves to stunted growth of business and operations. Sensing this looming prospects, the RBI in its ‘Report on Trend and Progress of Banking in India 2009-10’ cautioned that 11 out of 21 PSBs were very close to the floor of 51% shareholding and that, “this raised the important issue of recapitalization in order to ensure continued credit creation by PSBs if the statutory floor of 51% for government shareholding had to be maintained’ (op.cit. Paragraph 4.65, Chapter IV). The impact of sticking with the inflexible policy of holding a minimum of 51% of shares in all the PSBs will soon unravel itself.

It must be said to the credit of the Government of India, ministry of finance that following the Budget speech by the then finance minister, it came out with detailed directions on 22 February 2005 on the issue of grant of autonomy to PSBs which is known as “Managerial Autonomy for the Public sector Banks”. This document spelt out the clear demarcation between “the roles of owners, the board of directors and the executive management”. It went on to state that the “The objective is to ensure that banks function on sound principles of corporate governance. The key issue is to design a framework in which government will exercise its ownership rights without transgressing into the management functions of the PSBs”. For the stronger banks, autonomy is granted in 12 different areas while others have freedom in eight areas of operations in addition to the existing ones. PSBs could not have asked for more but in the recent past, how this autonomy has come to be chipped away is dealt with in later paragraphs.
In 2005 the government owned 100% shares only in four out of the 19 nationalised banks. At present in all the nationalised banks, and IDBI Bank and State Bank of India i.e. PSBs, the government has less than 100% holding; in almost 14 of them the private shareholding exceeds 30%. The 2005 document on Managerial Autonomy showed sensitivity of the government to the changing pattern of ownership; it is worthwhile quoting from this document: “The existence of private shareholders in the PSBs imposes a responsibility on the government, as the majority shareholder, to enhance shareholder value and protect minority shareholders’ rights. The government will create an environment conducive for PSBs to raise additional funds from the market for meeting the Basel II requirements and to respond effectively to emerging competitive pressure”.

The private shareholders are allowed to elect one director for each 16% of the holding. In practice, the PSBs are able to persuade the institutional shareholders who represent the bulk of private shareholding to vote for the candidates indicated by them.  Not infrequently the government informally advises the PSBs the names of candidates whom they want to show favour; this sometimes compromises the independence of such a “shareholder director” as he/she would remain obliged to the government rather than to the private shareholders or even to the bank. Incidentally, it may be mentioned that the PSBs have so far not faced shareholder activism questioning the preferential treatment of public sector borrowers; some of such conventions might be difficult to defend as commercial decisions. The recent legal challenge initiated by The Children’s Investment Fund management [TCI], with just 2% shareholding against Coal India should be a warning to PSBs, more so to the government “against transgressing into the management functions” (please see quote in paragraph four above).

(A Banker is the pseudonym for a very senior banker who retired at the highest level in the profession.)

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