The road not taken

Sidestepping the radical reform measures suggested by the Nayak committee is a sure-shot way to aggravate the NPA crisis

kaushal

Kaushal Shroff | October 6, 2016 | New Delhi


#finance ministry   #public sector banks   #NPA   #PJ Nayak committee   #Indradhanush scheme   #Banking  


In May 2014, a committee headed by PJ Nayak, former chairman and CEO of Axis Bank, came out with a report that laid out a roadmap for setting public sector banks (PSBs) free from the government’s ownership. The report was prescient in its assessment of the weakening balance sheets of PSBs and yet the government has done little in executing its recommendations.

The report cautioned that PSBs were registering lower profit margins and productivity ratios of these banks were on a decline vis-à-vis their private sector counterparts. It pointed out that PSBs have been consistently losing out on market share and the asset quality under these banks has been of a sub-optimal investment grade. The Indradhanush scheme initiated almost a year after the release of the report incorporated a number of recommendations from it. However, many recommendations have been watered down and some have been ignored altogether.

For example, the Indradhanush scheme fails to address the question of reducing the government stake in PSBs below 50 percent, which is one of the key suggestions of the Nayak report. Any substantial and far-reaching change in the functioning of PSBs can come about only when dual regulation of the public lenders by the RBI and the finance ministry is eliminated. The political interference in the form of fiats from the finance ministry only serves to work against the banks and not for them. Between October 2012 and January 2014, the finance ministry issued 82 circulars to PSBs. Private banks, on the other hand, only have to answer to RBI.

Reducing the stake below the half in PSBs- as laid down by the report- is a move that is sure to invite backlash from a number of stakeholders. However, that alone shouldn’t deter the government from setting reforms in motion. Inactivity on this front will only add to the government’s total cost burden on recapitalising public lenders.

The level of stressed assets and NPAs has already reached 15.4 percent of all gross advances for PSBs. Juxtapose this with the private banks’ figure of 4.4 percent. While the figures for private lenders do raise concerns, they are still healthier than their public-sector colleagues, thanks essentially to the freedom private banks enjoy when it comes to disposing of non-performing assets. Public bank officials often don’t operate with a free hand when it comes to taking a large haircut on projects that are under the cloud, for fear that their actions will be subsequently investigated by agencies. 

In the meanwhile, an increasingly widening portfolio of NPAs keeps drowning profit margins of public lenders as they race against a deadline of March 31, 2019 to meet the international Basel III capital regulations meant to strengthen the risk management capabilities in the banking domain.

The Basel III norms mandate a basic capital adequacy ratio (CAR) – the amount banks are supposed to hold in proportion to their loans – of 9 percent, along with a capital conservation buffer at 2.5 percent of the risk-weighted assets, which takes the total minimum CAR required to 11.5 percent, much higher than the 9.62 percent they are currently required to maintain under RBI regulations.

An Assocham-NIBM study has pointed out that PSBs will need a massive Rs 5 lakh crore to meet the mandatory Basel III norms on minimum capital. The report, proceeding on the assumption that Indian banks will record at least 20 percent credit growth in the short-to-medium term, has said that banks would most likely need core equity of Rs 1.75 lakh crore and non-equity capital of Rs 3.25 lakh crore, to be raised through tier-I and tier-II bonds (Banks are required to maintain tier I and tier II capital in the form of reserves, bonds and other instruments so as to enable them to absorb losses arising from the bank’s activity).

The study delineated the two-fold challenge facing PSBs: Firstly, majority ownership of the government means that a sizeable chunk of the recapitalisation will have to be injected by the government, which is showing signs of reluctance in indiscriminately pumping funds in all PSBs. Secondly, the dismal performance of the PSBs will work against them when it comes to raising capital from the bond market.

The situation already looks grim for a number of banks. Barring the State Bank of India (SBI) group, most of the lenders have gross NPA (GNPA) that exceeds 10 percent of their total loans. Further, the net interest margin for these banks grew at a lowly aggregate level of 3.2 percent for the quarter ending June 2016. With such dismal performance, the possibility of raising adequate amount of capital through AT-1 tier bonds becomes all the more costly as PSBs have to sweeten the deal by offering higher coupon rates. AT-1 bonds are debt instruments that form part of the tier I capital and mandate coupon payment on a yearly basis.

The coupon rates offered in AT-1 bonds by the Indian banks are in the range of 9-11.5 percent; significantly higher than other senior bonds that have a better rating between AAA and A+. Bonds of the latter category offer lower coupon rates between 7.5 and 9 percent and considered much more safe investment. The coupon on the AT-1 bonds comes out of distributable reserves with the company, that is, current year profits (or in case of loss, from the revenue reserves). With the net distributable reserves as percentage of total assets coming in negative or low for many public banks, even the investors are deterred from investing in these bonds.

Meanwhile, with the banks cleaning up the bad loans of their loan books, their balance sheets have been hit by a double whammy. It has led to a  massive capital erosion along with a stagnation in credit growth as private sector banks are moving in to corner the market left wide open by PSBs.

At such a delicate stage, the government would have done well in walking the radical reform path marked out by the Nayak committee. Primary among them is the repeal of Acts that restrain the government from divesting its share in these banks. The report recommended that the Bank Nationalisation Acts of 1970 and 1980, together with the SBI Act and the SBI (Subsidiary Banks) Act be repealed followed by their incorporation under the Companies Act and the setting up of a Bank Investment Company.

This has not come to pass. Indeed, the government has settled down with the creation of a Bank Boards Bureau (BBB). The BBB, as per the Nayak report, was to advise the centre on appointment of chairmen and executive directors of the banks and was to comprise three senior bankers of high standing. Instead, the BBB as formed under the Indradhanush scheme comprises a chairman and six members. The new BBB is thus merely a dressed-up old selection committee.

Here’s why: In August 2014, SK Jain, CMD of Syndicate Bank, was arrested by the CBI for allegedly accepting a bribe of Rs 50 lakh. Later, the CBI found that his appointment itself was inappropriate which led the government to step back on the selection of a number of PSB heads and revisit the selection procedure. The selection committee was to comprise of an RBI deputy governor, the financial services secretary and four other officials.

Curiously, the BBB under the Indradhanush scheme has the same composition, with the secretary, department of financial services, and secretary, department of public enterprises, also playing a role in the selection of banking heads. This makes sure that the government still has its say in the selection of bank CMDs, in complete and direct violation to the intent of the Nayak committee report.

Nayak seemed unhappy with the modifications brought about to his BBB concept by the government. Comparing the Indradhanush BBB to a finance ministry committee, he told the Business Standard: “Can we not think of an independent body that makes these appointments? BBB has been announced by the government as well but in a very different way (from his report)… If you put the DFS secretary and RBI deputy governor on the BBB, you don’t change anything. We had thought of a completely independent professional body. You might as well not have a BBB of that kind and have a committee in the finance ministry to handle it; it really does not substantively make any difference.”

As the government refuses to loosen its grip on PSBs, its recapitalisation of PSBs under the Indradhanush scheme amounting to Rs 22,900 crore is too little restore market confidence.

Fitch Ratings in a report released in September said that at end-June 2016 the total capital adequacy ratio (CAR) for 11 banks was at or lower than the minimum of 11.5% required by end-March 2019. 

This is a terribly worrying sign. The clock’s ticking for the government.

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