The govt’s push for SME loans via PSBs, relaxing the IBC norms for NPAs in certain sectors and relaxing the capital conservation requirement for certain banks smacks of the prevalence of the policy mindset that brought about bank nationalisation.
Nationalisation and financial sector reforms have been two major milestones in Indian banking, making 1969 and 1992 landmark years in India’s history. While financial sector reforms brought about a sea-change in the way in which India does banking, there is a sense now that we may just be going back to the ‘command economy’ days.
Nationalisation was about driving the socialist dictat where mass-banking was the guiding principle, and banks were to be used as instruments for delivering social good. Banks were taken over by the government, and only the small, niche players remained, the ones that are called the old private banks today. The rest became public sector banks. Once owned by the government, they were used for furthering political agenda and initiatives like loan melas caught on where favours were forcibly dispensed. There was scant attention paid to loans being serviced or repaid, and, therefore, banks looked very profitable as their asset size increased. Appointments were made by the government and, in return, compliance was the norm. More importantly, there was little accountability and rarely were the banks questioned. Default in debt service by borrowers was addressed by giving additional loans so that the earlier ones could be repaid. The system was in a comfortable equilibrium.
Once we entered the world of reforms, the Narasimham Committee was instituted where the best global norms were studied and implemented very well. This brought in income recognition standards and the quality of assets was important. Once an asset turned non-performing, provisions had to be made, which brought down the profits. Also, lending was benchmarked against the ‘own capital’ of the bank, and, hence, capital adequacy standards came in. It took around a decade for the system to adjust fully. Competition was ushered in through new private banks that provoked comparisons regularly.
Both sets of banks have progressed well on a comparable scale, and technology, which has been a driver for the private banks, has been adopted by the PSBs, too. The quality of service in PSBs is comparable today to that in private banks, and the product offering is on a par though there could be some laggards in the PSB ecosystem where legacy issues have to be fully tackled. The case of overstaffing in PSBs is also a thing of the past, and the difference in culture has come down.
However, PSBs still have some major challenges that are remnants of the nationalisation days. First, they continue to be owned by the government, which means appointments are driven by a different ethic. Second, they continue to be the tool to drive the agenda of the government; a very good example is the Jan Dhan scheme that had been pushed on these banks irrespective of the viability. Third, the focus on SME loans, through the MUDRA window, is also a PSB task. Fourth, when infrastructure had to be funded after the DFIs got converted to banks; the onus fell on these banks that had to perforce channel funds to sectors like power, telecom, steel, textiles, etc. A large part of these loans have turned NPAs, an issue that is at the core of the larger problems facing the banking sector today. Fifth, when farm loan waivers are announced by the government, they cover the loans disbursed by PSBs, and anecdotal experience shows that often banks find it hard to get the money from the government when the latter has fiscal strains; this, in turn, leads to write-offs at a later point of time. Sixth, while interest rates are supposed to be freely determined by banks based on commercial considerations, often PSB heads are summoned to North Block and given instructions to lower interest rates. Seventh, political calls on loans have been a part of tradition where bankers may have to disburse loans on ‘instructions from above’, though this has reduced considerably of late. Eighth, targets are actually set on farm loans in the Budget, and passed on to the PSBs that have to ensure that the growth rate is maintained—this could be beyond the 18% priority sector stipulation already there.
It is not surprising that contradictions have surfaced in the form of PSBs saddled with several challenges. The important question is that a call has to be taken on whether or not we are serious about banking reforms and maintaining the sanctity of the system. The problem is not with the concept of a PSB, but with the processes involved and the lack of independence in operations. This kind of ambivalence has made the situation puzzling.
Hence, while we have taken several good points from the Narasimham Committee Report and implemented them to make the system world-class, at the operational level, there has been a flip-flop attitude. The approach towards prudent regulation has also been hazy. While moving to the 90-day norm was well implemented when the infra-NPA pile came up, soon enough , it was back to the days of nationalisation where we followed the policy of evergreening assets to book lower NPA levels. This escalated the problem to such proportions today that it has become hard to overcome.
The same mindset is in play when it comes to SME loans. While there is a genuine concern here, the can has been kicked once more by allowing for restructuring. It was done post-demonetisation and once again this year. It may be hoped that this is a one-off case and is not replicated in the years to come.
We have actually done very well on capital adequacy norms by pursuing an aggressive policy. While relaxing the norm on capital conservation buffer (0.625% to March 2020) to release capital for lending will not impinge on the strength of the system, it is the compromising mindset that is a concern as it sets precedents that can be used for further relaxation of norms in future. Also, the call on relaxing the standards for NPA recognition in certain sectors in the context of the IBC has meant moving a few steps back.
The time has come for us to take a concerted view on the banking system. While going strictly by the book can have pitfalls in terms of bringing in considerable rigidity, flexibility should be the last resort and not the first option. Otherwise, as can be seen, the general mindset has tended to move back towards the days of nationalisation where the ‘social cause’ became a justification for all actions. While there is nothing wrong in both the models, moving continuously from one to the other not only smells of uncertainty but also fails to anchor the main objectives of the system. If we opt for the old school, then there should be less discussion on prudential regulation and more on over-riding social benefit. We cannot have both for certain.
The author is Chief Economist, CARE Ratings Views are personal