Consolidate and privatise banks

Giving up ownership is essential to ensure that they do no relapse with the same systemic weaknesses.

By Author Dr K Srinivasa Rao   |   Published: 23rd Aug 2017   12:35 am

Mowed by the milling asset quality woes and consequent capital dilution, public sector banks (PSBs) are in a tough spot. The solutions are not easy and structural transformation is the only way out.

Many prominent committees, including the first Narasimham Committee report of 1991, recommended merger of banks into 3-4 groups with a defined geographical and functional coverage. Two of its major recommendations — consolidation and disinvestment in PSBs by government — are yet to be implemented.

The non-implementation of these two key recommendations continue to haunt the banking system. The missing link in governance needs to be addressed to restore the sustainability of PSBs.

On the Fast Track

The discussions in the first-of-its-kind ‘Gyan Sangam-2015’, a conclave of top bankers, led to the launch of a seven-point reform package –‘Indradhanush’. While its implementation was still a work in progress, the second ‘Gyan Sangam-2016’ harped on the imminent need for consolidation among PSBs. But implementing such an idea is always challenging.

However, encouraged by the success of the merger of the SBI and its associate banks, the proponents of bank reforms are now determined to move ahead with consolidation plans to bail out banks from the weaknesses. The inevitable reasons for some of the PSBs to have reached the brink of consolidation include fast deterioration of assets quality, exacerbation of asset quality woes due to asset quality review (AQR) launched to unveil the correct state of asset quality, additional provisions against new stock of bad debts pushing most PSBs into losses in FY16, diminishing Provision Coverage Ratio (PCR) and mounting capital needs of the PSBs to be able to continue to lend and prepare to comply with Basel-III by 2019.

Prompt Corrective Action

Looking at the state of PSBs, perhaps as an early warning signal before consolidation, the Reserve Bank of India revised the Prompt Corrective Action (PCA) matrix from April 1, 2017, and imposed it on some of the identified weak PSBs. These PSBs need to work within the contours defined by the RBI. Prominent among the PSBs under the scanner of PCA include Indian Overseas Bank, United Bank, IDBI and Dena Bank, and the latest being Central Bank of India and Bank of Maharashtra.

The revised PCA is very clear in indicating the three thresholds with its set performance parameters, each indicating the depth of bank’s weakness. The RBI has also indicated its attendant consequences – restrictions on lending, hiring staff and branch expansion to begin with.

The RBI’s transparent PCA ready reckoner makes it very clear as to the banks that are in its queue. So the individual banks can proactively look at its own performance parameters and can bring about improvements to avert its imposition. Even those close to Threshold–I can act now to prevent it.

As far as broad customer segments are concerned, it is ‘business as usual’. But the PSBs operating under the PCA are on the watch list and their task is cut out – improvement of (i) asset quality, (ii) return on assets and (iii) capital adequacy ratio is critical.

In a way, the constructive guidance of the RBI is providing enough opportunity to such PSBs to improve through a focused approach. Further deterioration to Threshold–III will lead to closure or merger. The RBI has made the way forward clear for these banks with its revised PCA. If weaknesses persist, the future is bleak.

Resolve Governance Deficit

In the given circumstances, while the merger of weak banks with strong banks is a logical proposition in consolidation, it may not add much value unless pruning of manpower and branch network is quickly and effectively undertaken on a substantial scale.

If the rules of governance remain same even in the few newly-carved out strong consolidated PSBs, the net operating results will also remain same. The arithmetical summing up of NPAs, capital and profits of merged entities may look better in the short run but cannot be a panacea for the ostensible governance deficit.

Therefore, along with consolidation, dilution of government stake below 51% will be ideal to infuse private enterprise in the newly-formed strong state-owned banks. There is no point in holding on to the ownership of PSBs, which will be susceptible to dual control (government and RBI) with the same systemic weaknesses that are prone to relapse too soon. While undertaking the exercise of consolidation among PSBs, an equally serious introspection is needed to privatise them.

Pursue Privitisation

With the new form and structure, if privatisation is pursued, the new entities can freely adopt the successful operating models akin to private banks. Better performance management, awards and rewards linked to business, systemic marginalisation of non-performance will pave the way for dynamic exit of incompetence. Fixing accountability for the business outcome in a better way and many more business-oriented management styles of private enterprise will find space.

Learning from the outcome of governance of PSBs in the last close to five decades, more than consolidation, it is privatisation that is the essential solution. Hence, the suggested approach could be two pronged – consolidation and privatisation.

Any short cuts in taking risks at this stage by holding on to majority ownership may invite repetition of the wrath. As far as control on the banking system and continuation of directed credit for productive sectors of the economy is concerned, all banks operating in the financial system are ultimately responsible to pursue national priorities set out by the government.

Hence, structural reforms in PSBs should use both tools of consolidation and privatisation to restore agility to the banking system.

(The author is Director, National Institute of Banking Studies and Corporate Management (NIBSCOM))