Banking revamp bill won't burn a hole

Jaideep Mishra ET 6 Aug 2014

The Reserve Bank of India's recent report of the Committee to Review Governance of Boards of Banks in India is a bit of a misnomer as it really pertains to public sector banks (PSBs).

However, the roadmap for reforms outlined therein need to be purposefully followed through, especially in the backdrop of allegations of impropriety by Syndicate Bank chairman and managing director SK Jain going out of his way to prevent corporate loans being declared non-performing assets.

The report of the committee, headed by PJ Nayak, former chairman and CEO of Axis Bank, does call for autonomy, legal restructuring, greater accountability and thorough professionalisation of PSB boards, including independent directors with domain knowledge, and a special category of Authorised Bank Investors.

Along with gradualism, what the Nayak committee's scenario analysis suggests is that to be in line with Basel-III norms, banks would need Rs 2.10 lakh crore of tier-I capital during 2014-18, with the government having to invest Rs 1.26 lakh crore.

The Nayak panel's other two scenarios suggest far more capital, but the government seems to have accepted the above figure as a rough working target as finance minister Arun Jaitley's Budget speech did mention of the need to "infuse Rs 2,40,000 crore as equity by 2018 in our banks".

The report details the weakening of PSBs, having as they do lower profitability and productivity ratios than their private sector competitors, and they have lost significant market share as well, with asset quality much weaker, "in some cases, worsening to grave proportions".

The essential point is that the Centre needs to set aside about Rs 1.26 lakh crore for bank capitalisation, which would add up to, say, outlays on two largish heads in the annual Budget, and so seem eminently doable, provided there is the requisite political will and legislative sanction for change.

In parallel, what's required is innovation and customer-focused banking so as to provide greater sophistication in the products on offer. For instance, there's the need for depth in both futures and options contracts on long-term government bonds, so as to facilitate greater liquidity and other risk-mitigation measures. It would lead to similar innovation in the corporate bond market, which would bring about much-needed liquidity in such instruments.

While the massive mortgage-backed securitisation that led to the financial crisis in the US was gross recklessness, we do need the more orthodox banking innovations here.

The fact is that the new private banks have been far quicker at process innovation and fee-based services, moving, for instance, repetitive customer transactions out of bank branches and making them fully centralised. More important, the Nayak panel calls for alternative style of control of PSBs, to overhaul incentives, remove constraints and avoid conflict of interest.

It mentions Axis Bank as an example, whose ownership was "one hundred per cent in the public sector and yet it was awarded a private sector bank licence". What is envisaged is that the government distance itself from routine governance and oversight functions and all banks be incorporated under the Companies Act, in a three-phase reform process.

To begin with, what is proposed is that a Bank Boards Bureau should advise on all board appointments. What is conceived is setting up of a Bank Investment Company to which the government transfers its holdings in banks.

It would require wide-ranging human resource policy changes like longer tenures, succession planning and redesign of vigilance oversight. In tandem, also suggested is large block shareholders to improve governance; the Budget speech proposes direct retail shareholding in banks. The point is to boost bank performance with innovative legal structures.

Recall that bank nationalisation back in July 1969 was unabashedly for paramount political reasons. As the late IG Patel mentions in his memoirs, Indira Gandhi summoned him and said, "For political reasons, it has been decided to nationalise the banks. You have to prepare within 24 hours the Bill, a note for the Cabinet and a speech for me to make to the nation on the radio tomorrow evening. Can you do it and make sure there is no leak?" Touché.