By Janmejaya Sinha
As the virus devastates lives and livelihoods, one unintended victim will be Indian banking. In the new language of the virus, those with co-morbidities will suffer. In the economic sense, public sector banks (PSBs) entered the crisis quite fragile, and are likely to be seriously hit. The economy will see growth rates take a 10% negative swing. Some sectors will be ravaged. The knock-on effects from these sectors will flow directly to banks. Many of their loans will go bad. RBI had allowed moratoriums, which will bunch up and could create a negative impact by next year. RBI had no choice then, and, now thankfully, has allowed a one-time restructuring of loans to companies in the ravaged sectors to even this out. But, the severity of the crisis cannot be wished away.
Banks will need capital; otherwise, they will essentially be bankrupt. Insecurity in the populace is high—Rs 200,000 lakh crore went to savings accounts in SBI as a rush to safety. The risk premium between the rate SBI offered on savings (2.75%) and that offered by some private players of around 7%, captures the concern. How should the government respond?
The basic choice will be determined by RBI. Either RBI can loosen its prudential norms to a pre-1992 era and not recognise bad loans. This will allow banks to carry on operating with a lower velocity of credit in the economy, given government ownership prevents runs on banks, as depositors feel their savings are safe. Or RBI could insist on a recapitalisation of the banks by an extremely cash strapped government. Those who look west for all their answers will find the first answer heretical. Those who look East (at China, Korea, Taiwan) may be less shocked. However, both options are tough.
In all this, is there a sensible option? Remarkably, there is. It is well known and has been around for 25 years. It is not hard to do, but some mental block prevents it from happening. The government could become the single largest owner of nationalised banks instead of being a majority owner. It could bring its shareholding down, below 50%. The same rules as RBI has for private banks where a promoter cannot hold more than 26%. No other owner could own more than 5%. This is a powerful, overdue, recommendation.
The government remains the owner. However, the banks’ management then get decision-making autonomy. Needless interference and the paralysing fear of vigilance goes away. It affords HR the freedom to recruit, retain and develop talent. In all of this, it does not restrict the ability of the government to direct these banks in a “non-discretionary” way. Non-discretionary in line with policy, but protected from discretionary interventions to provide meals at a political rally or run guest houses that bureaucrats could use. By bringing ownership down to 26%, the government’s need to provide capital to these banks goes away. In fact, due to the dramatic rise in book value that will accompany this action, it will give the government more capital than the value of its current larger holding.
More broadly, such a model will go towards levelling the playing field in terms of ownership norms.
It could also possibly provide a model for the world, especially developing countries, where you marry the stability of government ownership with the dynamic pressure of market forces seeking efficiency and profitability. It challenges the simplistic notions of privatisation that we always talk about looking at the west as the ideal type. Private banks in the US have had crises at regulator intervals, most recently in 2008. Innovation in financial services has also mostly come from outside the industry. Financial innovations within the industry have largely profited the players and negatively impacted the consumers—thereafter, the industry has been good at privatising profits and socialising losses.
Some accompanying reforms can also help. Large non-bank finance companies (NBFCs) should be forcibly converted or acquired by banks to mitigate systemic risk. While easy NBFC licensing should continue to spur financial innovation, NBFCs over a certain size should be converted into banks. The logic of allowing entities to borrow short term money wholesale and lend longer term is without logic. They have existed due to the inefficiencies of PSBs, and due to the constraints they have operated under. Bringing government ownership levels down will hurt NBFCs anyway, but I have always struggled to understand the essential illogic of allowing industrial houses NBFC ownership, but preventing them from owning banks. As if an industrial house will find it easier to default on an Indian depositor rather than a public sector bank (from where they currently get most of their funds).
With this same penchant of looking west rather than east, India prematurely abolished development finance institutions (DFI) when the government forced IDBI to become a commercial bank. Concessional funding to DFIs was stopped, and SLR status was taken away from their bonds, making their model unviable. Since then, project finance and money for infrastructure was to come from commercial banks. The system did not work so well, and since then all experiments at creating institutions that would tap into the bond markets—IDFC, IIFL, NIIF—have all failed. China in the meantime has created two new DFIs in addition to the big ones it already had, lending trillions of dollars in project finance.
I don’t even want to go into other regulatory anomalies like cooperative banks in this piece. I will just end by continuing to wonder what is it that prevents the government from bringing down its holdings in PSBs to below 50%, but above 26% shareholding. Someday, somewhere, someone will be able to explain this to me. Till then the thought for a post-Covid world is to imagine a new PSB avatar—a model for the world?