Of late public sector banks (PSBs) have been in a mess: Be it a surge in the numbers of loans going from good to bad, or the unwillingness of bankers to take bold measures for fear of getting entangled in vigilance inquiries, PSBs are going through a bad phase.

And given the intensity of competition in the banking sector is only set to increase, it may be time to reduce government interference to ensure that PSBs get the freedom to take their own decisions and bring in greater operational flexibility. Or at least this is what the RBI governor Raghuram Rajan had to say on Tuesday at the annual day lecture at competition commission of India (CCI).

Clarifying that he was not hinting at privatisation of banks, Rajan highlighted the need to change the governance and management structure at these banks to enhance their competitiveness in a sector “on the cusp of revolutionary change”: “If public sector banks become competitive, and especially if they do so by distancing themselves from the influence of the government without sacrificing their ‘public’ character, they will be able to raise money much more easily from the markets." (Read the full text of Rajan’s speech here.)

“Privatisation is not necessary to improve the competitiveness of the public sector," he further said, "but a change in governance, management, and operational and compensation flexibility are almost surely needed in India to improve the functioning of most PSBs.”

Predicting that the intensity of competition within the banking sector in India will increase manifold in coming times, the RBI governor said the stability in status quo will be demolished and access to more funds for the better performer will be ensured.

Rajan’s remarks clearly hinted at his inclination towards accepting the suggestions of the PJ Nayak committee, which had submitted a report to review governance practices in the PSBs earlier this month.

The Nayak committee has suggested, among others, to create a holding company to hold government’s shares in PSBs, increasing the length of tenures of PSB chiefs, separating the position of chairman and CEO, and appointing more independent directors on bank boards.

This could be a radical step towards improving the performance of PSBs which have been miserable given the soaring bad loans and dropping profitability. And the staff crunch problem at PSBs is not helping.

Apart from poaching of talent by private banks, PSBs are also set to lose out on a huge chunk of its middle- and top-level management, due to retire in the next three years. The government's failure to chart out manpower requirements at the earlier stages is to be blamed for this crisis. And the subsequent failure to retain their talent by providing a challenging work environment, motivating employees and compensating them adequately has only worsened the situation.

In addition, the governor pointed out the problem of constantly questioning the decisions of the bank employees by the vigilance department, which often puts them on the back foot.

“PSBs need to be able to recruit laterally, while retaining the talent they have, but to do so they need to be able to promise employees responsibility as well as the freedom of action,” Rajan said.

At present, PSBs are run by the party in power to promote their own interests, even if it means hurting the financials of banks. Reckless lending to close associates of politicians is not an unknown phenomenon and this too has contributed to the bad loan menace.

PSBs should be given a lot more autonomy to run keeping their own interests in mind and this can only be done by distancing themselves from government influence without compromising on social welfare. The Nayak committee's recommendation to dilute stake of government in the PSBs is a good starting point and this should not be put on the back burner.

Private banks operate with a stronger talent pool and are slowly but surely gobbling up the PSBs' market share. Ensuring greater operational flexibility and a stronger framework for governance at PSBs will help them bounce back into the game.