Last week, the government announced its plan to consolidate the public sector banks (PSBs) from currently 21, to 10-12 in the next few years, and create 3-4 global level behemoths such as SBI, which is already among top 50 biggest banks in the world. As the first step, many associates of SBI have already been successfully merged with the parent company. RBI also favours the creation of the multiple levels banking structure in the country, where large global banks such as SBI, co-exist along with the regional banks such as Andhra Bank, and the local level banks. However, the purpose of such an exercise leaves a huge doubt in people’s mind, as to what the government is trying to achieve?
Our PSBs have not really risen to the expected standards. Recent reports suggest that PSBs faced 56% growth in bad loans in 2016 compared to previous year. This is set to rise, due to setback to the SME segment during demonetisation. Gross NPAs have also been reported to have risen to Rs 618,872 crore. Bad loans have risen by 135% in last two years, and constitute 11% of PSBs’ gross advances. According to Care ratings, the gross stressed assets ratio of PSBs was 15.8% of advances as of September 2016, of which agriculture’s gross stressed assets ratio was 7.2% (NPA ratio was 6%) while industry’s figure was 22.3% (NPA ratio was 15%). Analysis suggests that within the industry, the highest gross stressed assets ratio was among industries such as base metals, etc (42.6%), construction (27.9%), textiles (21%), food processing (20%) among few others. What is more alarming is the comparison of PSBs with private banks. While SBI has below 8% NPA ratio, and even its associates are almost all below 10%, some PSBs such as Indian Overseas Bank have an NPA ratio of 20.26%, UCO bank (17.18%), United Bank of India has 15.98%, Punjab National Bank has 15.4% among others. By comparison, private sector banks have low NPA ratios. ICICI Bank is at 4.7%, HDFC bank at 1%, Axis Bank at 2.6%. The average NPA ratio of the Indian Banks is 9% while for the US banks, it’s less than 1.5%.
The lessons to be learnt are that PSBs’ NPAs and gross stressed assets ratios are unreasonably high due to political interference.
As of September 2016, Large borrowers (with exposure more than `5 crore) had 56% share of credit, but 88% share of total NPAs. These borrowers often rely on bigger banks (or their syndicates) for bigger ticket loans. Thus, based on a logical presumption, it can be argued that creation of larger banks in India would create bigger loan sizes, and, thus, higher defaults. This would retard the cleaning of balance sheets for the larger PSBs today.
In a recent review of largest 500 exposure of Indian banks, RBI has suggested that top 12 NPAs (accounting for exposure of over Rs 250,000 crore, largely in Steel and Infra) be sent for resolution under the Insolvency and Bankruptcy Code (IBC). Interestingly, in half of these top NPAs, SBI is the lead banker. Half of these top 12 NPAs have also been referred to the National Company law Tribunal. Apart from SBI, PNB, IDBI Bank, and Corporation Banks are also other PSBs affected by this exposure.
The message is very clear. Private banks take exposure based on commercial terms of the loan proposal based on a tradeoff between risk and return, after sufficient due diligence. Unlike their private counterparts, the PSBs give loans to these firms based on political welfare, what can popularly be described as crony capitalism. Consolidation of PSBs, rather than their privatisation (like done for PSUs in oil ) suggests that banks which were nationalised in 1980s for the sake of national growth and social equity have become a potent tool for the political class for their own welfare. Not only it’s a blatant violation of fiduciary trust on part of the political class, it also smacks of the pseudo-agency problem for the PSU bank honchos.
The agency problem arises when the agent (PSU management in this case) fails to align its goals with those of their principal (the government in the case of the PSBs). A pseudo-agency problem appears to be so when the agent appears to be in alignment with the principal (in this case since the stressed loans were given with the blessings of the political class, and hence the goals are aligned), under the appearance of social or business welfare.
Bigger banks in India have become weaker by giving larger loans under this pseudo-agency problem. Since PSB bosses find it difficult to resist the political pressure to extend loans to industrialists when backed by political support. However, the private sector banks have tried their best to push back such proposals, by finding merit in commercial terms of the loan proposals, although their NPAs still exist, largely due to errors of judgments, and the vagaries of the business or economic cycles faced by the industries. It would augur well for the future of PSBs to remain small and regional. India needs more Andhra Banks, and Punjab and Sind Banks than SBI like behemoths, which after merger with associates would become a too-large-to fail bank.
Writer is Associate professor, Marketing, IIM Calcutta