The growth imperative

Updated: May 26 2007, 05:30am hrs
One casualty of the Left support to the UPA is turning out to be the growth of public sector banks (PSBs). Banking regulation requires that banks hold a certain amount of capital as a proportion of risk-weighted assets. Capital adequacy norms require that if lending is growing fast, so must equity capital/reserves. Thus, banks have to not just grow in terms of deposits and assets, they also have to widen their capital base at the same rate. While deposit growth has been strong, with the Indian economy growing fast, and public sector banks have been doing well, their equity capital has not been growing. Growth in profits of these banks, which can be ploughed back as reserves, has not been adequate to meet the requirement. Not only are these banks restricted by social responsibility objectives and political interference, the inability to cut labour coststhanks to employee unions and labour lawsand the lack of a profit-oriented incentive structure mean that there is a crisis amidst a business boom.

The obvious solution would be to let public sector banks raise funds through public equity issues. But since this would reduce the governments share of equity ownership in these banks, this has not found favour with the government. Nor has it been injecting capital into these banks. Given the capital crunch, an option for the banks is to limit deposit growth, which can be done by offering lower interest rates and curtailing their branch network expansion. The banks could also go slow on lending. This, too, would mean a loss of market share. Private sector banks like ICICI, which plans a huge public issue soon, will then be able to grow much faster without any capital inadequacy problem. It would be better, however, if the government gives at least some public sector banks the freedom to raise capital and get on with their job. For some of them, capital can be raised without any loss of government control; reportedly, Punjab National Bank may soon see government ownership drop to 51%. This is welcome. Looking further, however, there is no option but to take some hard decisions. The government must act fast, or else, the banking sector will suffer.