The government has indeed taken decisive policy steps for real sectors and areas such as power, agriculture, infrastructure, manufacturing and labour. And the Reserve bank of India (RBI) has just issued a consultative paper with a new set of recommendations on ownership in the banking sector. If implemented, the proposed suggestions could trigger an influx of deep-pocket long-term capital from new sources, which can transform the banking sector.
On reforms in the financial sector, and more specifically in public sector banks (PSBs), it is important to look at some of the performance parameters relating to them. After consolidation, we now have 12 public sector banks.
The top four PSU banks account for 75 per cent of the asset size of the all the PSBs. The overall performance of the bottom eight remains a significant concern with an average return on assets at a meagre 0.18 per cent and average return on equity at just 4.57 per cent. Additionally, the cumulative market-capitalisation of the bottom eight PSBs is just ~20 per cent of total market cap of the top four banks.
Over last three years, the Government of India has poured in approximately Rs 3 lakh crore for recapitalisation of the PSBs. Given the introduction of new-age technologies in the last decade, and the competition from new-age banks and non-banking finance companies (NBFCs), these smaller PSBs could become a big drag on the exchequer for capital support and for depositor protection.
In 2014, RBI had set up a committee under the chairmanship of Dr PJ Nayak to look into the state of the PSBs and to make recommendations on their future. Given the lower productivity, steep erosion in asset quality and demonstrated uncompetitiveness of these banks over varying time periods (as evidenced by inferior financial parameters, accelerating stressed assets and declining market shares), the committee reconfirmed that recapitalisation of these banks will entail significant fiscal costs.
If the governance of these banks continues as at present, it will impede fiscal consolidation, affect fiscal stability, and eventually impinge on their solvency.
Consequently, the committee recommended two options to the government: either to privatise these banks and allow their future solvency to be subject to market competition, including through mergers; or to design a radically new governance structure that can better ensure their ability to compete successfully, in order that repeated claims for capital support from the government, unconnected with market returns, can be avoided.
As banking is a strategic sector, the government should retain a controlling stake in the top four PSBs. However, for the remaining eight PSBs, which are much smaller but fiscally risky, the government should consider reducing its ownership and bringing in another strong strategic owner. The strategic local or global partner should be invited to put in significant capital in these PSBs and even take controlling stakes.
The key issues in executing this will be to ensure security of funds for existing depositors, protection of pension of employees and recovery of bad assets. To address these issues, the strategic buyer should be required to put in substantial capital to maintain a high level of capital adequacy and liquidity after accounting for asset write-offs.
Additionally, adequate provision for managing the existing employees and pension liability should be maintained. The strategic buyer should be allowed to buy 51-75 per cent stake in such banks through primary infusion. The requirement of open offer will have to be waived, as capital will be required to go into the bank. The government should retain some stake along with the public shareholders, who could benefit by from re-rating of the stock due to future efficiencies.
Finally, since the strategic buyer will be required to contribute significant capital immediately and on an ongoing basis, anyone with deep pocket in India or a strong global financial services player could be allowed to participate in the process, of course with the fit-and-proper check.
The recommendations of the RBI panel, if implemented, could ensure that there are enough suitors to bring in the long-term capital from new sources to these PSBs.
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