On 24th October, the ministry of finance announced a bank recapitalisation programme that would put Rs2.11 lakh crore into public sector banks (PSBs). Of this, banks will get Rs18,000 crore directly from the government under the Indradhanush programme; they will raise Rs58,000 crore from the market and the government will pump in Rs1.35 lakh crore through recapitalisation bonds. The rating agencies, business community, fund managers and analysts have all heaved a sigh of relief that the heavy weight bad loans have been lifted from the PSBs which had been caught in a vicious cycle. PSBs have accumulated close to Rs10 lakh crore of bad loans, or 12% of their loans & advances. They have no incentives to go after the defaulters. The government, that is, the ministry of finance, does not have the time and resources to go after banks which they part-own and fully control. If PSBs write off these loans, their net worth would be wiped out and they would not have been able to make fresh loans which, in turn, would mean poor economic growth. Poor growth would mean more bad loans.
To break this vicious cycle, the government has announced a recapitalisation plan. Unfortunately, not only are the details of the bailout package unclear, there are no strings attached to it either. Such bailouts have been attempted earlier too; they give temporary relief to PCBs at the cost of taxpayers but the core operations, characterised by corruption and inefficiency, remain the same and go on to generate more bad loans. The absence of any conditions attached to the bank bailout is a surprising omission in a series of ineffectual steps the government is taking to revive PSBs. People had expected this government to make fundamental changes in the way PSBs operate; their expectations have been belied.
Fixing the PSB mess was perhaps a priority for the prime minister Narendra Modi in 2015; just seven months after he assumed power, the finance ministry organised a two-day retreat branded ‘Gyan Sangam’ in Pune on 2-3 January 2014. The gathering included the who’s who of banking: heads of all public sector banks and financial institutions, the finance minister, Raghuram Rajan, the then governor of the Reserve Bank of India (RBI), the then minister of state for finance Jayant Sinha, and top officials of the finance ministry, including the finance secretary and financial services secretary. Mr Modi interacted with bankers on the second day of the retreat, “in an attempt to achieve a broad consensus on what has gone wrong and what should be done both by banks as well as by the government to improve and consolidate the position of PSBs.” Foreign consultants made long presentations. Finally, nothing came of it. A second Gyan Sangam was held the next year, but it was a damp squib. Far from becoming competitive, profitable and customer-friendly, PSBs sank further in the morass of bad loans as they were kept busy with opening Jan-Dhan accounts and, later, demonetisation. Many remained headless for a long stretch.
Then, on the eve of Independence Day in 2016, the government launched Indradhanush, a seven-point programme to rejuvenate PSBs. The plan covered better senior appointments, setting up a Bank Boards Bureau (BBB), pumping in more capital, reducing bad loans, empowering the management, improving accountability and better governance. Indradhanush did not work either. The government has done a few things that were easy to do, but have little connection to the core problems that beset PSBs: one, some top-level appointments, two, more capital and three, setting up BBB. Four other components of Indradhanush remained on paper: reducing bad loans, empowering managements, improving accountability and better governance. These objectives have been discussed and debated by many committees in the past.
No Accountability Fixed So Far
Even as more capital is injected into PSBs, shouldn’t someone be held accountable for the huge mess? RBI’s role involves framing banking policies, implementation of plans, banking supervision and senior appointments. It receives scores of reports from banks, conducts regular inspections and nominates directors to bank boards. Despite this, PSBs are in a mess. What has RBI done with the reports that banks are asked to submit? Did its inspections report nothing suspicious about the dubious loans that turned bad? What role did the RBI-nominated directors play even as banks kept lending recklessly? Who in RBI is responsible and accountable for all this? If no one is accountable, how do we make RBI primarily accountable as the banking regulator?
Then come the banks. The spread between the average deposit rates and average lending rates (known as spread) in India is one of the highest in the world, making banking a highly profitable business. If banking is a profitable business, why do PSBs need such repeated bailouts? The average ratio of bad loans to advances of PSBs is 10% while the average ratio of bad loans to advances of the five largest private sector banks is 1.5%. Why are bad loans six times higher in PSBs? From the RBI governor to bank officials and ministers, everyone says that India needs better bankruptcy laws (we now have it). Why were operations and profits of private sector banks not badly hampered because of weak bankruptcy laws?
Bankers are supposed to be cautious people. Indeed, small businessmen tell us that it is very difficult to borrow from banks, without offering collaterals and personal guarantees that are several times the size of loan. Banks also arm-twist businessmen to buy life insurance if they want a loan. If bankers did their due diligence correctly and acquired collaterals and guarantees in excess of the loan, why is recovery so difficult when the loan goes bad? If loans have gone bad on such a large scale, is it correct to conclude that banks have not done the basic job of lending and appraisal correctly? The inescapable conclusion is that behind the colossal bad loans lies corruption and gross inefficiency. But how many bankers have been held accountable for this?
Lending by PSBs is fundamentally flawed. If the government continues to control these banks, how can we reward exceptional bankers and punish the corrupt and inefficient ones? The Narendra Modi government came to power in May 2014. The same month, the PJ Nayak committee (Committee to Review Governance of Boards of Banks in India) submitted its report to RBI. The report was widely hailed as a fine roadmap for PSB reform. Sadly, the current government has not picked up anything much from that report. The core problem with PSBs, as the Nayak committee saw it, is this: “Governance difficulties in public sector banks arise from several externally imposed constraints. These include dual regulation, by the Finance Ministry in addition to RBI; board constitution; significant and widening compensation differences with private sector banks; external vigilance enforcement through the CVC and CBI…”
The solution suggested by the committee was: “If the Government stake in these banks were to reduce to less than 50 percent, together with certain other executive measures taken, all these external constraints would disappear. This would be a beneficial trade-off for the Government because it would continue to be the dominant shareholder and, without its control in banks diminishing, it would create the conditions for its banks to compete more successfully. It is a fundamental irony that presently the Government disadvantages the very banks it has invested in.”
Every solution thought by the government, skirts this core problem and does not come anywhere near this elegant solution. Each government has been conceited enough think that it can set things right. Instead of trying to set things right, we should have a system that automatically prevents wrong things from happening. This is precisely why the Nayak committee had suggested that the government bring down its stake which would eliminate a host of issues automatically. Quite the opposite has happened again—government stakes are going up in the process of recapitalisation, without any strings attached.