Banking reforms: Why privatization is better than Bank Mergers - Pragnya IAS Academy - News Analysis

Banking reforms: Why privatization is better than Bank Mergers

Some public sector banks are fast losing their relevance. By merging them with relatively strong banks, we will end up eroding the strength of India’s banking system.

Bank privatization will address the issue of moral hazard of the government. As long as it remains majority owner in public sector banks, it will not be easy to have the bail-in clause that the FRDI Bill proposes.

It does not happen often. Last week, both the Reserve Bank of India (RBI) and the finance ministry had to step in to quell widespread rumours of some public sector banks being closed.

“No question of closing down any bank. Government is strengthening PSBs by (Rs) 2.11 lakh crore recapitalisation plan. Do not believe rumour mongers. Recap, reforms roadmap for PSBs firmly on track,” financial services secretary Rajeev Kumar tweeted even as RBI issued a press release clarifying that “the PCA framework is not intended to constrain normal operations of the banks for the general public.”

The framework is 15 years old now. Introduced in December 2002, it was reviewed early this year and a revised version was put in place in April 2017. This will be reviewed again in 2020.

The PCA framework tracks three key areas of bank operations—capital, asset quality and profitability—through the capital adequacy ratio, or the ratio of capital to risk-weighted assets (CRAR), net non-performing assets (NPAs) as a percentage of loans and return on assets (RoA). Besides, it also monitors the leverage of a bank or the amount of debt used for financing assets.

The framework has laid down three risk thresholds and once a bank breaches the “risk threshold 3”, it becomes a candidate for resolution through tools like amalgamation, reconstruction, or even winding up. Breaching of the first two thresholds makes banks subject to restrictions on dividend distribution and remittance of profits (in case of foreign banks), branch expansion and compensation of senior management, among others.

A bank is placed under PCA framework on the basis of its audited annual financial results and the supervisory assessment made by RBI. However, the regulator may impose PCA on any bank during the course of a year or migrate a bank from one threshold to another if the circumstances so warrant. In the case of Bank of India as well as United Bank of India, this is what happened last week. While Bank of India was brought under the PCA framework, Kolkata-based United Bank of India, which was put under PCA three years ago, migrated from one threshold to another.

To be sure, none of the banks that have so far been put under PCA meets the criteria for being wound up. However, this does not mean that they just have flu. They have cancer; depending on the stage of the disease, they need radiation, chemotherapy and surgery even though RBI statement has attempted to play down the affliction, saying the PCA framework is a supervisory tool which monitors certain performance indicators of banks as an early warning exercise and the objective is to facilitate the banks to take corrective measures in a timely manner to restore their financial health.

So far, 10 PSBs have been placed under PCA framework. They are Indian Overseas Bank, Dena Bank, Corporation Bank, Central Bank of India, IDBI Bank Ltd, Uco Bank, United Bank of India, Bank of Maharashtra, Oriental Bank of Commerce and Bank of India. Collectively, they have a deposit portfolio of Rs25.26 trilion, 30.55% of the total deposits of all public sector banks. Similarly, they have a 30.08% share of the loan book of the public sector banking industry and their share of PSB banking assets is 30.44%. So, there is no point in remaining in a denial mode; we must accept that close to one-third of India’s public sector banking industry is sick.

The situation is unlikely to improve fast. Going by RBI’s December Financial Stability Report, NPAs of Indian banks will rise further even though the financial system as a whole remains stable. Under the Indian central bank’s base case scenario, gross NPAs in the banking sector may rise from 10.2% of advances in September 2017 to 10.8% in March 2018 and further to 11.1% by September 2018.

“Earlier, the June report had warned that the banking system’s gross bad loan ratio would rise to 10.2% in March 2018 and for public sector banks, the gross bad loan ratio could be as much as 14.2%. The Financial Stability Report is a biannual reality check of the Indian financial system, in vogue for eight years.

The rise in bad loans would also hit the capital adequacy ratio of banks. Under its base case scenario, two banks may have a CRAR below the minimum regulatory level of 9% by March 2018; and, if the macro conditions deteriorate, as many as six banks may record a CRAR below 9%. The CRAR of the entire banking system may decline from 13.3% in March 2017 to 11.2% in March 2018, the RBI report has pointed out.

The International Monetary Fund (IMF) too has flagged the risks to the Indian banking system on account of its deteriorating asset quality. IMF’s assessment of Indian financial sector’s stability, also released last week, points out that the large banks are sufficiently capitalized but many others are “highly vulnerable to further declines in asset quality and higher provisioning needs”.

The need for additional capital ranges between 0.75% and 1.5% of India’s $2.44 trillion GDP. The IMF stress tests covered the 15 largest banks, which account for 71% of the banking assets in India. The list includes 12 PSBs. IMF has urged the Indian government to consider privatization of weak PSBs by selling their viable assets instead of merging them with stronger banks.

This suggestion merits the owner’s attention. Some of the public sector banks are fast losing their relevance. By merging them with relatively strong banks, we will end up eroding the strength of the system. Instead, privatization is a better solution even though politically it is an extremely difficult task.

Privatization will also address the issue of moral hazard of the government. As long as the government remains the majority owner of these banks, it will not be easy to have a law that the Financial Resolution and Deposit Insurance Bill 2017 (FRDI Bill) proposes, asking depositors to sacrifice in case of a bank failure.

(Source:livemint)

Banks Board Bureau: Old wine in a new bottle?

The Government set up Banks Board Bureau to improve the governance of public sector banks but the problem of bad loans, raising capital, and an overhaul of the banking sector cannot be done by merely asking the bureau to select bankers for top jobs.

About Banks Board Bureau

• The bureau was announced by the Union Government in August 2015 as part of seven point Indradhanush Mission to revamp the PSBs.
• BBB will be a super authority (Autonomous Body) of eminent professionals and officials for public sector banks (PSBs). It will replace the Appointments Board of Government.
• It will give recommendations for appointment of full-time Directors as well as non-Executive Chairman of PSBs.
• It will give advice to PSBs in developing differentiated strategies for raising funds through innovative financial methods and instruments and to deal with issues of stressed assets.
• It will also guide banks on mergers and consolidations and also ways to address the bad loans problem among other issues

Composition of the Banks Board Bureau

• Vinod Rai, a former comptroller and auditor general of India, is the chairman of the bureau.
• Its members include Anil K. Khandelwal, a former chairman of Bank of Baroda.
• H.N. Sinor, a former joint managing director of ICICI Bank Ltd.
• Roopa Kudva, a former managing director of rating company Crisil Ltd
• Then, there are three ex officio members—
  
  • R. Gandhi, a deputy governor of the RBI
  • Anjuly Chib Duggal, secretary, department of financial services, in the ministry of finance; Ameising Luikham, secretary, department of public enterprises.

Why Government wants Banks Board Bureau

• Government wants BBB to restructure business strategy of PSBs and also suggest way forward for their consolidation and merger with other banks as they are grappling with a huge problem of bad loans and high collective gross NPAs (Non-Performing Assets).
• Saddled with a large pile of bad assets, public sector banks need huge amount of capital.
• They also need to focus on sharpening efficiency and strengthening corporate governance.

How will the board help banks in developing strategies and raising capital?

• If there is no change in the constitution of the board and the bureau does not have any say in the selection of independent directors, it will be difficult to help these banks develop strategies and raise capital as many directors on the boards of various banks neither understand strategy nor do they lend credibility to their institutions.

Inception of BBB

• A committee set up by the RBI to review the governance of bank boards, headed by former chairman and managing director of Axis Bank Ltd P.J. Nayak, in May 2014 had suggested the formation of the bureau as a first stage in a three-phase process to empower the boards of public sector banks.
• In the run-up to the incorporation of a Bank Investment Company as an intermediate holding company for these banks, the bureau would advise on all board appointments, including the whole-time directors and the top bank management, to ''professionalize and depoliticize'' the appointment process. the panel had recommended.

BBB is meant to be a temporary provision, until Bank Investment Company is set up.

• The government has maintained that BBB is the first step towards a holding company for the government's stakes in the public sector banks and facilitate consolidation in the sector.
• According to P.J.Nayak Committee, the members of the bureau would have a tenure of three years or until powers are passed on to the investment company, whichever is shorter, and their remuneration would at least be on a par with the senior bank chiefs.

Why it is temporary?

• The investment company can be set up only after legislative changes. And it is a time-consuming activity (considering the recent trend in the way of functioning of the Parliament)

According to the author, BBB is a Old wine in a new Bottle. How?

• The government has done nothing, but has replaced the earlier appointments committee with the bureau.
• As there is no change in its constituents: An RBI deputy governor, two bureaucrats and four external experts—Rai, Khandelwal, Sinor and Kudva.

What should be done?

• It will not be easy to raise capital unless the government plans to overhaul the way public sector banks operate and this cannot be done by merely asking the bureau to select bankers for the top jobs.
• The government must clarify whether it is an intermediate step towards setting up the investment company.
• And if it is, then the scope of work must be widened to include the appointment of independent directors of the board, as envisaged by the Nayak committee.
• It also must look at the tenure of the managing director and the chief executive and the compensation of senior bankers, among other things. Finally, the process of appointment must also change.