Non-performing asset (NPA) of banks and Priority sector lending (PSL)

Issue — Consolidation of PSB/Banking consolidation

• The trigger for consolidation is the high NPAs which are eroding, not the net worth but the profitability of many public sector banks and the government is under pressure to capitalize them.

Background

• There are in total 27 disparate public sector banks
• As far back as early 1990s, the Narasimham Committee on financial sector reforms had recommended it. Several finance ministers had espoused the idea publicly.

Advantages

• The merger benefits include getting economies of scale and reduction in the cost of doing business.
• Technical inefficiency is one of the main factors responsible for banking crisis. The scale of inefficiency is more in case of small banks. Hence, merger would be good.
• Mergers help small banks to gear up to international standards with innovative products and services with the accepted level of efficiency.
• Mergers help many PSBs, which are geographically concentrated, to expand their coverage beyond their outreach.
• A better and optimum size of the organization would help PSBs offer more and more products and services and help in integrated growth of the sector.
• Consolidation also helps in improving the professional standards.
• The size of each business entity after merger is expected to add strength to the Indian Banking System in general and Public Sector Banks in particular.
• After merger, Indian Banks can manage their liquidity — short term as well as long term — position comfortably. Thus, they will not be compelled to resort to overnight borrowings in call money market and from RBI under Liquidity Adjustment Facility (LAF) and Marginal Standing Facility (MSF).
• This will also end the unhealthy and intense competition going on even among public sector banks as of now. In the global market, the Indian banks will gain greater recognition and higher rating.
• The volume of inter-bank transactions will come down, resulting in saving of considerable time in clearing and reconciliation of accounts.
• The burden on the central government to recapitalize the public sector banks again and again will come down substantially.
• This will also help in meeting more stringent norms under BASEL III, especially capital adequacy ratio.
• A great number of posts of CMD, ED, GM and Zonal Managers will be abolished, resulting in savings of crores of Rupee.
• This will also reduce unnecessary interference by board members in day to day affairs of the banks.

Disadvantages

• Merger will affect regional flavour and end regional focus.
• The large global banks failed during financial crisis while the small ones survived
• Immediate negative impact would be from pension liability provisions (due to different employee benefit structures) and harmonisation of accounting policies for bad loans recognition.
• There are many problems to adjust top leadership in institutions and the unions.
• Mergers will result in shifting/closure of many ATMs, Branches and controlling offices, as it is not prudent and economical to keep so many banks concentrated in several pockets, notably in urban and metropolitan centres.
• Mergers will result in immediate job losses on account of large number of people taking VRS on one side and slow down or stoppage of further recruitment on the other. This will worsen the unemployment situation further and may create law and order problems and social disturbances.

The weaknesses of the small banks may get transferred to the bigger bank also.

• Clash of organisational cultures
• When a big bank books huge loss or crumbles, there will be a big jolt in the entire banking industry. Its repercussions will be felt everywhere.
• Also, India right now needs more banking competition rather than more banking consolidation. In other words, it needs more banks rather than fewer banks. This does not mean that there should be a fetish about small-scale lending operations, but to know that large banks are not necessarily better banks.

Issues involved

• Timing of the merger: A qualified, independent board of directors — appointed by a specially-constituted board — would naturally be able to better direct merger moves, if needed. The consolidation process should wait until the major recommendations of the Nayak Committee are implemented.
• Capital adequacy: If a big bank were to absorb a smaller one, it is assumed that the former will be adequately capitalised and have a better grip over its non-performing assets, at least compared to the bank it seeks to absorb. That may not be the case in the present scenario. Bigger PSB fair poorly on this count
• Human resources: challenge there is enormous. Many of the issues — such as upgradation of employee skill sets — need to be addressed on a priority basis even if the consolidation process is in the distant horizon.
• Is ‘bigness’ a necessary attribute for a bank to function effectively in India and abroad?

Various committees

Various committees appointed by the government and RBI have studied in detail the aspects of consolidation through the process of mergers.

Narasimha committee (1991 and 1998) suggested merger strongbanks both public sectored even with the developmental financial institutions and NBFCs.

Even the Khan committee in 1997 stressed the need for harmonization of roles of commercial banks and the financial institutions.

Verma committee pointed out that consolidation will lead to pooling of strengths and lead to overall reduction in cost of operations.

Way forward

• Consolidation among government banks might be a desirable goal but at the moment both the concept and the roadmap suggested are highly theoretical.
• Consolidation is a right move but needs proper planning, strict measures and compliance with guided norms to avoid future risks.
• Government should not rush into the merger
• All stakeholders must be taken into confidence

Issue — SBI merger with associate banks

Advantages of merger of SBI with associate banks

• SBI will have global presence among top 50 Banks, bringing confidence, investment and greater lending.
• SBI can become one of the anchor banks to finance large infrastructure projects like dedicated freight corridor, solar energy, Sagarmala etc.
• It will increase networking of SBI all over India, thus better services of SBI compared to its associate branches will be able to reach remote locations.
• It will reduce duplication as SBI and its associates target the same clients with similar products.
• It will consolidate resources and infrastructure, reducing the cost on operations, human resource and technological solutions, overlapping bank branches, reduce inter-bank transaction cost etc.

Disadvantages of merger

• Presently these banks have huge NPAs thus merger should be planned after sufficient capital is injected.
• Banking competition may be affected, as SBI is likely to be five times larger than its nearest competitor.
• RBI has declared SBI as Domestic Systemically Important Bank (D-SIBs) and its failure can shock other parts of financial system.
• Past example of large banks and their failure with financial crisis in Japan, USA, etc.
• Workers resistance from associations like AIBEA calling for strikes India has poor financial inclusion, thus needs variety of banks and differentiated services.

Scheme — Bank Board Bureau (BBB)

• As part of the indradanush plan, the government has announced the setting up of Bank Board Bureau (BBB) that will give way to holding company to which the Centre will transfer its ownership of all these banks.
• The idea was first mooted by PJ NAYAK COMMITTEE

Details:

• The BBB will be headed by a Chairman and will comprise six other members — three government officials and three experts, two of which will be from the private sector.
• It will make recommendations for senior appointments and also advise banks on strategies for consolidation among them including mergers and acquisitions.
• The BBB will also be a link between the government and banks and will be engaged with banks to evolve strategies for them.

Importance

• large NPA in PSB
• The Bureau is mandated to play a critical role in reforming the troubled public sector banks.

Way forward

• The bureau should also have a say in the selection of independent directors of boards without which 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.
• 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

Scheme — Mission indradhanush

• The government has announced a seven-point action plan, Indradhanush to infuse professionalism and fresh capital in to public sector banks

The following are the seven main concerns that Indradhanush seeks to address (ABCDEFG)

• (A) Appointments — Keeping in mind global best practices, the post of Chairman and Managing Director are to be seperated and there would be another person who would be appointed as non Executive Chairman of PSBs.
• (B) Banks Board Bureau (BBB) — Bank governance the exiting Appointments Board is sought to be replaced by a BBB, which will be tasked with appointment of chairpersons and directors, besides guiding PSBs on matters of strategy.
• © Recapitalisation — Infusion of Rs 25,000 crore of capital in debt-laden banks.
• (D) Bad loans — NPAs burden of PSBs is sought to be addressed by way of developing vibrant debt markets for PSBs besides strengthening of asset restructuring companies and addressing the issues of stalled projects.
• (E) Empowerment — In this regard, banks have been assured that government will not interfere with their functioning besides allowing them flexibility in hiring manpower.
• (F)Accountability — A new framework — Key Performance Indicators (KPIs) has been proposed to measure the performance of PSBs
• (G) .Governance — Regular Gyan Sangams, i.e., conclave of PSBs and financial institutions has been proposed to discuss the process of governance reforms

Concerns regarding Indradhanush

• (A) Critics argue that periodic bailout are akin to flushing money down the drain. Instead, they propose that recapitalisation must be strictly performance based.
• (B) Given that the BBB will continue to have government nominees on board, it is nothing but a rechristened form of the exiting “Appointment Board”. BBB could continue to face government interference in matters of appointments resulting in the casualty of merit.
• © P J Nayak committee’s recommendation regarding the setting up of a Bank Investment Company run entirely by professions, to which the government’s equity stakes in PSBs would be transferred, has largely been ignored.
• (D) The Nayak Committee proposal on parity of practices between private and public banks has also been ignored.
• (E) The measures in relation to NPAs are nothing but a reiteration of the existing measures being taken by the RBI and government in this regard.
• Non-reference to disinvestment.
• Experts believe that the real reform is for the government to vest the ownership of all the banks in a single holding company, whose board comprises professionals of integrity. It can select PSB boards and oversee their working

Way forward

• History is no precedent for the future as far as public sector banks are concerned.
• What has worked for them in the past may not do so now owing to the sheer pace of technology, innovation and customer-orientation that has swamped the banking sector.
• PSBs are in very real danger of losing not only their market share but also their identity unless the government intervenes with surgical precision and alacrity.
• Hence, policymakers and bankers need to put their heads together and come up with a smart option to resolve an issue that can no longer be put on the backburner.

Impact of financial inclusion initiatives

• The number of government social schemes that use PSBs is uncomfortably high. The schemes cover a range of areas such as insurance (Pradhan Mantri Suraksha Bima Yojana, Pradhan Mantri Jeevan Jyoti Bima Yojana, etc), pension (Atal Pension Yojana), financial inclusion (Pradhan Mantri Jan Dhan Yojana), and priority sector lending, which includes various schemes under agriculture, micro and small enterprises, education, housing, export credit and others.
• PSBs have spearheaded financial inclusion since the nationalisation of the State Bank of India in 1955. The presence of PSBs in rural areas is substantially higher than that of private banks.
• The role of PSBs in the attempt to extend financial inclusion to remote parts under the Jan Dhan Yojana has been exemplary.
• The share of private-sector banks in new accounts opened under the scheme is just 4 per cent. Of the 16 crore Jan Dhan accounts, nearly half are non-operational.
• The financial burden of maintaining and servicing such accounts is more on the PSBs.
• the biggest cost to banks is the opportunity cost they lose in implementing these schemes. Ambitious targets and time frames take up precious time that could have otherwise been used to carry out the original mandate of the banks — accept deposits and make loans.
• All normal bank activity comes to a standstill during such public drives, with employees being swamped by the targets

There are three sets of issues (GMO) in PSBs:

1. The key governance issues concern the composition and functioning of the board.

2. The important management issue is the selection of the CEO.

3. The operational issues are the resolution of non-performing assets (NPAs) and the infusion of capital in banks.

The government can bring out a sea change in PSBs by doing just three things:

• appointing the right CEOs
• backing them with the requisite capital
• bringing independent directors of competence and stature on board

P.J. Nayak Committee

Need

• The review is long overdue because the norms for bank boards in India were formed when a set of banks were nationalized and last nationalization took place in 1980. •
• The banking agenda itself has changed It is time to change the scheme of nomination to a bank board because the business now involves different products and different kinds of people who are well-versed with technology.

Report and recommendation of the committee

• While the above composition looks good, there is still a huge problem about the process of identifying individuals to represent these diverse interests. The Nayak committee rightly identifies it.
• It terms the boards as “non-independent” except for the shareholder directors.
• The process of the election of even these so called “independent” directors may also show that they are largely nominees of the government, albeit through a different process.
• They are elected by shareholders excluding the government. The non-government share-holding in many of the banks are substantially held by institutions indirectly controlled by the government — insurance companies, financial institutions etc.
• These institutions largely select the “independent” directors as well.
• We thus have a situation where the public sector banks end up not having a semblance of good corporate governance.
• Ownership of Public Sector Banks (PSBs): All PSBs should be incorporated under the Companies Act, 2013. The government should transfer its holdings in PSBs to a Bank Investment Company (BIC). Some of the constraints faced by PSBs could be removed if the government reduces its holding below 50%.
• Board appointments in PSBs: The process of board appointments in PSBs needs to be professionalised in a three-phase process.
• In the first phase, a Bank Boards Bureau comprising former senior bankers should advise on all board appointments.
• In the second phase BIC should take over the process.
• In the third phase, BIC should delegate these powers to PSBs’ boards.
• Private sector banks: Diversified investment funds should be allowed to hold 15–20% stake in a private sector bank without regulatory approval (currently, 5%). Other investors can hold up to 10% stake. The promoters should be permitted to hold up to 25% stake in a private sector bank (currently, 15%)
• While arguing for fundamental changes in the way the public sector banks function, the committee presents a compelling case by examining the performance of these banks in comparison with the private sector counterparts.
• Committee also says that bank falters if the focus is shifted away from financial parameters (in context of financial inclusion)

Way ahead

• The role of governance of bank boards is not a stand-alone issue that could be tinkered by recommending some changes here and there, but has to be examined comprehensively •
• Lowering the governmental stake 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 •
• This report is insightful, constructive and radical in its approach. However, accepting these recommendations needs political will. We are not sure that the ball lobbed into the court of the Government — by a committee appointed by RBI can find instantaneous resonance. We hope that the new government has the will to address these issues and reform the governance and management of banks, particularly PSBs.