By Mukta Malhotra

The issue is still in the backburner. It has been nearly a decade since reforms were kicked off, yet it is command economy for the Indian FIs. FIs such as IDBI, which sanctions an assistance of nearly Rs 28,300 crore on an average during a year and which has the potential to alter the contours of the Indian economy, continue to be controlled by the government.

To be sure, lack of autonomy is having far-reaching impacts on FIs' decision-making. Not being able to take quick market-driven decisions, FIs turn into roadblocks when it comes to putting through shareholder-friendly mergers and acquisitions and ushering in corporate governance in companies where they hold substantial stakes.

Punishing non-performers
But, this might not be the case with smaller companies. In the case of large companies, certainly the FIs are not able to take crucial decisions. Quite often, FIs' decision-making is influenced by political pressure. Says Nikhil Khatau, chief executive officer of the Mumbai-based Sun F&C Asset Management: "Though financial institutions are in a transition phase, I expect the FIs to make decisions based solely on economic rationale and not any other considerations."

The crippling inability to make decisions on merits of the case often leads to situations where the FIs are not able to dislodge non- performing and corrupt managements. This is a major stumbling block in creating shareholder values. Says a top IDBI official: "On paper, it might seem that we have freedom. But unofficially speaking, we cannot take major decisions freely." Concurs another senior executive with IDBI: "Normally, we shirk from making drastic management changes in any company because of the number of scrutinies we are put through. The board of directors can be anytime questioned by the chief vigilance officer or the various parliament committees."

That means the FIs, despite supposedly being the guardians of small shareholder interests, are not able to punish non- performing managements. There are ample instances of corporate misgovernance in India Inc. But precious little has been done by the FIs to bring about changes in their management in the larger interests of shareholders. Says Basudeb Sen, chairman and managing director of Industrial Investment Bank of India (IIBI), a Calcutta-based FI: "Changing management of companies is not an easy process in most cases, particularly when companies have failed to perform well. As corporate governance processes improve in the country, it would be difficult for existing managements not to give up their jobs once they fail to deliver shareholders value for successive years."

Hindering investments
As political pressure and interference continue to restrict government-controlled FIs from exercising their powers as major shareholders in companies where they have majority stakes, such absence of autonomy also adversely affects their own growth plans.

Consider mergers and acquisitions (M&As). FIs, by virtue of being large shareholders across industries and across companies within an industry, can offer their stakes to acquirers who can create more value for shareholders. They can put their stakes in non-performing companies on the block and thus play a proactive role in encouraging M&As. Effectively, the FIs can create a market for corporate control.

Alas, the FIs are not able to do this thanks to the fact that they are not market-driven. In the name of national interest, they are not able to dislodge corrupt and non-performing managements of companies.

This is a serious issue. For, the process of consolidation can only gather momentum in the coming years. and there is so much scope for consolidation in industries such as steel and cement. And, there are willing MNCs around eager to acquire and consolidate fragmented capacities. It is here that the FIs can play a proactive role not only by encouraging M&As, but also by financing them.

Limits on exposures
Not just in M&As, domestic FIs do not have the needed autonomy in many other areas. True, FIs have restrictions on the kind of industries they can have exposures in. Consider: section 2(c) of the IDBI Act 1964 lists out industries that IDBI can do business with and this list does not include housing, trade and real estate. All these sectors are growing and are profitable for financing. But, the FIs' hands are tied.

Such spokes in the wheel help only in making the FIs soft-pedal their growth plans. Most FIs prefer to stay away rather than going through the cumbersome process of getting their plans cleared by the respective ministries.

Hear what G P Gupta, chairman of the Mumbai-based IDBI, has to say: "With the introduction of economic reforms, there has been a paradigm shift in the business environment of developmental FIs. Industrial policy changes and WTO obligations have put pressure on the domestic industry, which is currently the main focus of IDBI. The domestic industry has to compete with global players. Further, with the WTO pact on financial services in place for some time now, there would be greater integration of the financial markets the world over. These developments have made it imperative for large developmental FIs such as IDBI to globalise their activities in a bid to optimise business prospects and reposition themselves to meet the requirements of the fast-changing operating environment."

The question here, however, is: do FIs have the autonomy and operational freedom to tailor their business initiatives to the changing environment?

Consider IDBI again. IDBI has identified international operations as it new focus. The FI is enthused about the growing international opportunities in areas such as project financing, investment banking, cross-border leasing and advisory services, among others. But, to kick off such international operations, IDBI needs clearance from the government. Says Gupta of IDBI: "Though IDBI can undertake certain specific overseas operations such as financing of turnkey projects or exports, in order to be generally authorised to undertake activities outside India, IDBI has recently written to the government asking it to issue a notification under section 9(1)(m) of the IDBI Act."

The implication of such requests is too well-known: clarifications and counter- clarifications, correspondence and counter-correspondence. All these only lead to inordinate delays. The time taken for such notifications could be anywhere between two months and a year. That means vital time is lost and the FI might not be able to capitalise on the emerging opportunities and gain a headstart.

Operational hurdles
Government control is also taking a toll on FIs' operations. The lowest quotation procedure which an FI has to follow does not allow it to do business with outsiders purely on the quality of services they offer. Says a senior IDBI executive: "Even for hiring the services of an outside consultant, regulations come in our way. And the lowest quotation might not necessarily be the best option."

Such operational hurdles hinder hiring right people. True, the FIs are under pressure, thanks to declining interest rates and squeezed spreads. So, it has become imperative for the FIs to venture into new economy businesses and fee-based operations.

But again, that calls for hiring people with sophisticated skills. And attracting such talents requires flexibility in recruiting and the willingness to offer attractive remuneration packages that include employee share ownership plans. But, the FIs do not have the freedom to make such offers.

So, it is loud and clear that lack of autonomy is preventing the FIs from helping companies create shareholder values. The question is: autonomy at what cost? Says V P Singh, IDBI's executive director: "The FIs have an advantage in being government-controlled: they are considered to be credit-worthy in terms of financial viability and safety and their ratings are next only to sovereign ratings. However, from the investors' point of view, being government-controlled is a big disadvantage. Investors' perceptions about the inflexibility of the government-controlled FIs are of course reflected in their share quotes." What Singh is saying is this: FI stocks are not the darlings at the bourses.

A question arises naturally here. If the FIs are not able to create value for their own shareholders, how can you expect them to play an effective role in ushering in corporate governance and shareholder value-creating dispensations in companies where they hold substantial stakes? It is necessary that the FIs become market-driven and shareholder friendly before they create such entities. That calls for a change in the mindset and the autonomy that can bring about such mindset changes. Says Khatau of Sun F&C Asset Management: "This change in FIs' mindset can be brought about by changing their structures."

That means the government should take initiatives to dilute its stake in the FIs below 51 per cent, perhaps to 25 per cent. And, the government should encourage the FIs to have professional management in place.

Breeding inefficiency
However, there are people who feel that the FIs need not become autonomous. Their argument: in a developing economy such as India's, the FIs have social obligations to fulfil. But, the argument does not hold much water. For, introducing social obligations certainly distorts allocation of resources and funding quotas can bring about skewed development. Let the market decide where the funds should flow. Moreover, autonomy would make FI executives more accountable to shareholders.

Moreover, the FIs have do not have much freedom to reshuffle their portfolios to achieve the benefits of efficient risk- management, optimisation of returns and effective containment of non-performing investments. This lack of freedom forces FIs to become complacent and ineffective.

So, pending autonomy, what should the FIs do now? They need to work as small development banks and strike an optimum balance between social obligations and commercial interests. Why cannot they have a commercially viable business model for discharging their developmental functions? As long as FIs are not granted autonomy, it will be a fertile breeding ground for inefficient companies resulting in grossly inefficient utilisation of scarce economic resources.