Last week, an RBI panel headed by former Axis Bank chairman PJ Nayak had suggested that the government cut its holding in public sector banks to under 50 per cent.
It said state-owned banks suffer due to 'externally imposed constraints' such as dual regulation by the RBI and the finance ministry and external vigilance by agencies such as the CVC and CAG, among others.
The Nayak report said if the government's stake in these banks were to reduce to less than 50 per cent, together with certain other executive measures, these external constraints would disappear.
The panel said the government should distance itself from several governance functions and all banks should be incorporated under the Companies Act. A bank investment company should be constituted and the government's holding in all banks should be transferred to this entity.
"These measures, if implemented, would be credit positive for public sector banks because they would address a key credit weakness," Moody's said in a report today.
The rating agency said corporate governance characterised by poor board supervision and excessive government interference is a structural credit weakness of public sector banks.
Government interference has meant that policy objectives, rather than commercial factors, have dictated some business decisions at these banks, it said.
The quality of the top management at such banks has been hampered by a non-transparent appointment process, relatively short tenures and a lack of accountability.
"The effects of this weak governance have become apparent as the economy has weakened, with public sector banks' performance lagging that of private sector banks in terms of asset quality and profitability," Moody's said.
"Once the banks complete the process of recruiting fully independent boards, the BIC (bank investment company) would transfer many of its oversight powers to the bank boards, leaving the BIC to operate primarily as an investor rather than as an owner," the report said.
The rating agency said the fear of being subject to probes by external agencies such as the CVC and CBI inhibits PSU banks from taking commercial risks that they deem acceptable and slows down the decision-making process.
However, Moody's said although it does not think that the government would allow its stake in public sector banks to fall below 50 per cent, there is a higher probability that the government would implement a watered-down version of the RBI's working group's recommendations.
"Even such an outcome would be credit positive for public sector banks," Moody's added.