Remodelling public sector banks

Privatisation to ensure capital-adequacy norms

Sanjeev Bansal

INDIAN banking is standing on the verge of “theatrical remodelling”, thanks to RBI Governor Raghuram Rajan's announcement. His enthusiasm for a "remodel" emerged way back in 2009 through the Committee on Financial Sector Reforms chaired by him. It is notable, however, that there is little novelty in the nature of the remodelling Rajan endorses. Whatever is being finished and what is scheduled to be completed are all schemes that were uncovered in the past by a string of committees — Narasimham I and II, Tarapore, Mistry, Rajan, to name a few.

RBI Governor Raghuram Rajan has to go through a giant trial, which is grounded on the assurance to shake up the public sector banks

Rajan's impact appears in the fact that he has commenced executing, in true earnest, the numerous proposals that were in progression. Largely, there has been considerable development in two areas. The first is the series of measures that provide foreign banks larger access to and additional sovereignty in the native banking cosmos. The other is the subject of new private bank licences, for which submissions have been entertained from domestic conglomerates and business clusters as well. The latter had been kept out of this cosmos since bank nationalisation. However, with the committee to scrutinise and select the submissions in place, anticipation is that one or more business groups would re-enter Indian banking. Rajanomics seems to be working, aided by extensive media backing, and probably the fact that now elections would inhabit the nation's attention.

Given the expectations of the stakeholders, the current Governor has to go through a giant trial, which is grounded on the assurance to shake up the public sector banks. The post-reform approach of the government towards public banks has been contradictory. On the one hand, banks have been poked into loaning to areas such as the retail segment and infrastructure, resulting in a mounting size of non-performing loans and a rising volume of restructured corporate debt. While restructuring has facilitated camouflage the degree of inherent default and dress-up of the financial accounts of banks, even the RBI's just-released report on trends in banking articulates concerns about the state of public bank financial statements.

On the other, the RBI and the government seem dyed-in-the-wool to warranting that Indian banks meet the steadily tough capital adequacy requirements set by the new Basel guidelines. Three consequences flow from this assurance. First, since the early 2000s, the government has been forced to permeate capital into the public banking system to fortify their balance sheets and push them into compliance of universally recommended standards. The government has so far infused Rs.746 billion into the public banking system, with bulk of it having been provided since 2009. However, this is far insignificant of estimates of what the banks would need if Basel III has to be complied with.

Secondly, with the government still expecting the banks to offer the credit that would finance private investment and consumption, non-performing loans are destined to increase. Henceforth, prospects are that the amounts required for recapitalising the progressively fragile bank balance sheets would escalate.

Thirdly, since the course of recapitalisation is under way, the kind of capital required to beef up the Tier I capital on bank balance sheets has altered. More importantly, what is necessary is tangible common equity capital. If this has to be guaranteed while keeping the government's equity holding in public banks constant, much public resources would be required. The former Governor of the RBI, D. Subbarao, had projected that the government, which holds 70 per cent of the banking system, will have to pump in Rs 90,000-crore equity in the public sector banks to preserve its shareholding at the existing levels.

If the government is to meet this requirement, it would not be able to do it with off-budget measures such as the issue of recapitalisation bonds as it did before 2010. It must now provide resources in the budget to buy into equity, with associated repercussions for expenditures. If revenue escalations cannot finance those expenditures, the fiscal deficit will expand, which goes in contradiction of the self-inflicted targets of the government. This has set off a demand that public sector banks should sell new shares in the open market to finance recapitalisation. But there could be one problem. The existing law entails that the government should hold at least 51 per cent equity in public sector banks. A case is being made that decreasing public shareholding from the present levels to 51 per cent will not yield sufficient capital for recapitalisation that permits realisation of Basel III standards. Hence, the case for recapitalisation has been converted into a case for privatisation of the Indian banking sector.

Thus the call for privatising public banks also predates Rajan. The Narasimham Committee on Banking Sector Reforms had as far back as 1998 called for a reduction of the government holding in public sector banks to 33 per cent to make them more vibrant. The Percy Mistry Committee had moved out further to claim that privatisation is desirable because state-ownership had adversely affected the quality of financial intermediation. The solitary transformation at the moment is that the case is being put up on the ground that privatisation is compulsory to ensure capital-adequacy norms.

Therefore, while delivering on the public bank segment of his agenda to "remodel" Indian banking, Rajan would only have to implement a policy that has been hard-pressed for fairly some time now. But then again, implementing this feature of the financial restructuring agenda is more challenging since it requires altering the law, which, in turn, has political dimensions. Although the modelling may be difficult to lay down, Rajan's view undoubtedly is quite optimistic.

The writer is a Professor of Economics in Kurukshetra University