January 12, 2015
A globally competitive economy requires a robust and competitive banking system. The present banking system is a result of reforms and policy changes that have taken place in the past.
Pre-1991, India had nationalized banks in two phases in 1969 and 1980. It meant that public sector banks (PSBs) controlled the credit supply. The post-1991 period can be thought of in three distinct chronological phases. The first one was roughly from 1991 to 1998. The second started from 1998 and continued until the beginning of global financial crisis. The third we believe is an ongoing process.
Post-1991 saw structural reforms in the financial sector (banking, capital markets and development finance institutions) based on the recommendations of the Narasimham Committee report of November 1991. Within the banking system, significant issues had arisen - namely a small capital base, overall fragile health, low profitability and less competition in the banking sector as a whole.
Measures to strengthen the capital base included capital infusion by the government of approximately Rs.20,000 Crore. In addition, public sector banks were allowed to approach the capital markets for infusion of equity capital subject to the condition that government ownership would remain at least at 51 percent.
Measures to improve the fragile health and low profitability included adhering to internationally acceptable prudential norms, asset classification and provisioning and capital adequacy. Several measures were also initiated, the prominent being the enactment of The Recovery of Debts Due to Banks and Financial Institutions Act in 1993. Following this, 29 debt recovery tribunals (DRTs) and five debt recovery appellate tribunals (DRATs) were established at a number of places in the country.
Apart from this, Lok Adalats were increasingly used for settling disputes between banks and small borrowers. Also, credit data started to be shared between banks for guarding against defaulters. Also, NPAs were clearly defined - based on objective criteria in four heath codes from the earlier eight. The new health codes resulted in approximately one-fourth of the total advances made being declared as NPAs.
All these measures reduced the percentage of NPAs to gross advances from 23.2 percent in March 1993 to 16 percent in March 1998. Further rationalization and deregulation of interest rates was also undertaken. The effective resolution of the NPA issue, combined with the deregulation of interest rates paved the way for greater competition and better profitability.
Simultaneously, to create competition within the banking sphere, several measures were undertaken. These included the opening of private sector banks, greater freedom to open branches and installation of ATMs, and a full operational freedom to banks to assess working capital requirements.
The second phase of reforms started with another Narasimham Committee report in April 1998, which succeeded the East Asian Crisis. Post 1998, a need was felt to restructure debt as the DRTs process was painfully slow due to legal and other hurdles. Therefore, a need to felt to build asset reconstruction companies. The enactment of the Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest (SARFAESI) Act, 2002 enabled the sale of financial assets to securitisation/ reconstruction companies.
Also, a Credit Information Bureau (India) Ltd (CIBIL) was established in 2000 that paved the way for the enactment of the Credit Information Act in May 2005, for credit information of borrowers. In accordance with this, gross NPAs as a percentage of total advances were brought down to 2.4 percent in 2008 from 12 percent in 2001.
Another feature of the second stage of reforms was the increasing competition between banks. Though 21 new banks (four in the private sector, one in the public sector and 16 foreign entities) entered, the overall scheduled commercial banks (SCB) reduced approximately four-fifths to 82 by 2007. Additionally, FDI in the banking sector was brought under the automatic route, and the limit in private sector banks was raised from 49 percent to 74 percent in 2004.
The third phase post the global financial crisis has again seen the NPAs steadily rising again. Data from the recently released Financial Stability Report of the RBI shows this increased to 4.5 per cent in September 2014. What is remarkable is that stressed advances (the NPA and Restructured Standard Advances) were at 12.9 percent of their total advances in September 2014 for PSBs in comparison to private sector banks at 4.4 percent.
Commenting on these developments Prime Minister Narendra Modi told a recent meeting of public sector bankers that he is against political interference but supports political intervention. Finance Minister Arun Jaitley similarly stressed the need to "deal with commercial issues with a commercial mindset".
Reserve Bank of India Governor Raghuram Rajan similarly hailed the government's decision in letting the PSBs be without fear or favour and ignore extraneous considerations in their commercial operations.
While all these statements highlight a firm intent to help public sector banks regain their competitiveness, it is equally worthwhile to observe that our financial system in the past has had higher levels of stressed assets, particularly in phase I and in the early part of phase II. That does not mean we have to touch those levels again. Maybe another round of reforms for the banking sector will reduce them. In 2015, the single biggest question facing the banking sector in general and the PSBs in particular will be ensuring reduction in NPAs with greater financial inclusion.
(The article is co-authored with Sankalp Sharma, Senior Researcher at the Institute for Competitiveness, India. is Chair, Institute for Competitiveness & Editor of Thinkers. The views expressed are personal. He can be reached at amit.kapoor@competitiveness.in and tweets @kautiliya. )
Public Sector Banks: At Cross Road-Indiainfoline
R Gandhi , India Infoline News Service | Mumbai | January 13, 2015 12:56 IST
In recent times, the PSBs position in the banking pecking order has been seriously challenged. There are lot of churning of ideas to restore greater strength in them.
Indian banking sector comprises of different types of institutions to cater to the divergent banking needs of various sectors of the economy. There are typical commercial banks which operate on all India basis. There are government owned banks, privately owned banks and foreign owned banks. There are also small banks with limited areas of operation. Credit cooperatives were created to cater to the credit, processing and marketing needs of small and marginal farmers organised on cooperative lines. Cooperatives expanded also in urban and semi-urban areas in the form of urban cooperative banks to meet the banking and credit requirements of people with smaller means.Regional Rural Banks were created to bring together the positive features of credit cooperatives and commercial banks and specifically address credit needs of backward sections in rural areas. Further, there was an experiment of establishing Local Area Banks, albeit on a smaller scale, to bridge the gap in credit availability and strengthen the institutional credit framework in the rural and semi-urban areas.
Most recently, we have decided to experiment with new types of banks under our differential licensing policy. Accordingly, we have invited applications for Small Finance Banks and Payment Banks. These banks will operate in their own niche areas of small finance and payments services. In India, the universal banking model is followed. As regards the structure of universal banks, the conglomerate structure is bank-led, i.e., banks themselves are holding companies which operate certain businesses through Subsidiaries, Joint Ventures and Affiliates.
The general principle in this regard is that para-banking activities, such as credit cards, primary dealer, leasing, hire purchase, factoring etc., can be conducted either inside the bank departmentally or outside the bank through subsidiary/ joint venture /associate. Activities such as insurance, stock broking, asset management, asset reconstruction, venture capital funding and infrastructure financing can be undertaken only outside the bank.
Lending activities must be conducted from inside the bank. Investment banking services are provided by the banks as an in-house departmental activity or through subsidiary.
a. Firstly, Capital Planning for PSBs needs to be considered over a long term horizon. Approximately, as high a sum of Rs 4.50 lakh crorein Tier 1 capital (which includes Rs 2.40 lakh crore equity capital) will be needed. Recently, it has been reported that the GOI is contemplating scaling down their holdings in PSBs to 52%. This may not be sufficient to fully meet the capital needs of the PSBs under Basel III norms particularly since the projections are based on minimum requirements. We also have to remember that Pillar II assessment has not taken off effectively/ fully as of now.
The PSBs will have to chart out a clear capital raising plan over the next five years.The PSBs should actively consider several options including, non- voting rights share capital, differential voting rights share capital, golden voting rights share capital, etc.
b. Secondly, there is a need to reflect on the Holding Company Structure in respect of the PSBs.The Nayak Committee recommendations in the matter look at the Bank Investment Company Structure from the limited perspective / single angle of separating the GOI investments from the PSBs.
There are deeper ramifications on this aspect and the whole issue must be looked at from multiple dimensions including that of the financial stability perspective. The suggestions made in the ShyamalaGopinath Report on the Bank Holding Company structure need to be given a serious consideration.
The objective must be threefold –
i) help reduce capital requirement impact on the GOI
ii) financial stability perspective,
and iii) strengthening corporate governance by reducing government influence and interference;
c. Thirdly, the Performance Appraisal System (PAS) needs a complete revamp.
Currently the PAS makes no meaningful distinction between individuals for identifying or deploying talent, skills and / or specialisation; nor does it guide determining compensation. The system needs reshaping so as to serve as the mainstay for evaluating employees’performance, assessing compensation and developing leadership.
d. Fourthly, the Public Sector Banks (PSBs) have hardly any meaningful participation in the financial markets, i.e in the BCD instruments.
This restricts / curtails the financial market development. A selected set of foreign banks and the new Private Sector Banks dominate the financial markets in India. PSBs need to engage proactively, especially, in the derivative instruments for hedging their risks. Treasury function is relatively weak in PSBs. Well established and robust Treasury is a must for the purpose; they must build up specialisation and should have sufficient number of specialists.
The vigilance aspect on treasury losses/ losses from transactions will need to be rationalised just as in other areas of PSB operations.
e. Fifthly, the PSBs should have a relook on their portfolios. Currently, their portfolio share in advances to agriculture, industries, services, retail and other services account for 13.90%, 46.32%, 20.93%, 15.74% and 3.11%. They will need to rebalance this, from the perspective of diversification.
f. Sixthly, the Retail Banking in PSBs needs a complete overhaul in terms of products, instruments and methods for deployment. As India is poised for re-entering high growth period, and as greater number of individuals will have higher income and higher financial needs, PSBs should be ready to meet these needs.
g. Seventhly, the PSBs should look at financial inclusion as a profitable business proposition and not as a matter of compliance with the RBI and government requirements. Extensive and smart use of ICT, mobile and internet banking as well as the Aadhaar linkage for customer identification and authentication can make this truly possible. Banks need to come out of the brick and mortar branch set-up mindset, and reorient the business models in accordance with changing times and requirements as well as improve profitability. We must not distrust the ability of the rural and/ or poor, small and marginal businesses/ operators/ farmers to understand and use basic / simple technology. The mobile and internet revolution in India has proved that already.
h. Eighthly, the PSBs should grab the opportunity offered to them during the GyanSangam, the retreat for the PSB chiefs at Pune last week. Now that Government has clearly articulated that the PSBs will take their own commercial decisions, the PSBs will have no excuse hereafter for any poor performance.
i. Ninethly, level playing field is on the cards. Already banking regulations and priority sector norms are increasingly owner agnostic. Now government also desires that the PSBs are professionally managed and operated. This augurs well for the PSBs. To conclude, we can easily agree that the PSBs are at the cross road. They are now being increasingly enabled to compete on professional basis. They are being assured of autonomy for their commercial decision making. Given these changed environment, it is time that they deliver value for the nation which provides its capital.
(Speech delivered by Shri R. Gandhi, Deputy Governor at the “Indian PSU Banking Industry: Road Ahead” Summit organized by Bengal Chamber of Commerce and Industry on January 10, 2015 at Kolkata) -
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