What Do We Do With Our Struggling Government-Owned Lenders?

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The earnings season is in full swing. A few private banks have announced their March quarter results—great, good and ugly—but none of the public sector banks (PSBs) have done that as yet. To be sure, they are never in a hurry to announce their earnings, but many of them are particularly inhibited this time around as their March quarter earnings would not excite the market. In the three months ended 31 December, the pack of 21 PSBs—which roughly has a 70% market share of banking assets in India—posted a loss of Rs18,097 crore, almost four and half times the loss posted in the previous quarter. One doesn’t need to be a Cassandra to say that the magnitude of loss will be far higher in March.

Sixteen PSBs posted losses in the December quarter, led by State Bank of India (Rs2,416 crore), the nation’s largest lender, and Bank of India (Rs2,342 crore). In the September quarter, 11 PSBs had posted losses. How many of them will find their balance sheets in the red in March is anybody’s guess at this point.

The Reserve Bank of India (RBI) has stepped in to protect the PSBs’ balance sheets by allowing them to spread the provision that they need to make good the erosion in value of their bond portfolio due to rise in yields (bond prices and yields move in opposite directions) over the next four quarters. However, there is no escape from setting aside money for their rising bad loans. On top of that, a few of them would need to plug the holes drilled by high-value frauds. Besides, most PSBs will see a drop in both interest as well as fee income as more loans are turning bad, making them ultra-cautious in giving fresh loans and forging new relationships with corporations.

In the December quarter, IDBI Bank Ltd topped the list of banks with the biggest pile of bad loans—almost one-fourth of its loan book. Three other banks had more than 20% of their loan portfolios turning bad—Indian Overseas Bank, UCO Bank and United Bank of India. Six other banks had more than 15% gross bad loans. While IDBI Bank had more than 15% net NPAs in December, there were seven PSBs with at least 10% net NPAs. Overall, this set of banks’ bad loans rose to Rs7.77 trillion in December from Rs7.3 trillion in September and, after provision, net NPAs rose from Rs3.7 trillion to Rs4.16 trillion.

Complan Boy Syndrome

Till some of them were threatened to be buried under the pile of bad loans, they were behaving like Complan kids. In 1980s, two kid models advertising the health food for children and who would become actors later—Shahid Kapoor and Ayesha Takia—were competing with each other on how fast they were growing, singing: “I am a Complan girl, I am a Complan boy”. And, they loved their “Complan mummy”.

Complan is all about growth of children. The PSBs are no children; in fact, many of them are more than 100 years old. They want to become taller (read bigger) but not necessarily stronger! That’s the genesis of giving loans indiscriminately by many banks—greed for growth. How long can their Complan mummy (read: the federal government) support them, using tax payer’s money?

What do we do with the set of PSBs? No one can deny the fact that they had played a stellar role in spreading banking to the masses and helped build roads and bridges, but the glorious past does not ensure a bright future. If they are to clean up their balance sheets overnight, many of them will go belly up as they don’t have enough capital. Delay in recognizing bad loans doesn’t help either as the PSBs will continue to make losses and there won’t be enough money to clean up; besides, delay in recognition and recovery erodes the value of assets.

Bank Investment Company?

There have been a lot of theories doing rounds on what should be done with the PSBs. A panel, headed by former Axis Bank Ltd chairman P.J. Nayak, which dealt with governance reforms in Indian banks, has recommended setting up of a bank investment company to hold the equity stakes of the government—a sort of passive sovereign wealth fund for the government-owned banks. It has detailed how and why this company should have autonomy and be professionally managed. We have not moved an inch on this proposal.

Of course, another recommendation of the Nayak Committee, the establishment of a bank boards bureau for selection of the chiefs of PSBs has been implemented but if the three-year term of the bureau’s first executive team is any indication, it has hardly made any change in the way PSBs are governed.

Narrow Bank?

Eleven of the 21 PSBs are now under the so-called prompt corrective action or the PCA framework of the RBI, which restricts their activities. This is close to a time-tested solution of addressing the bad loan syndrome—converting the universal bank into narrow banks that raise deposits from the public but do not lend, using the money for investing only in government bonds instead. However, this does not make much sense as unless a bank is able to support economic growth by lending, it has no right to live only as a deposit franchise.

Merger and Consolidation?

There have been talks about mergers and consolidation of PSBs. Everyone agrees we do not need so many of them, but no one is able to solve the puzzle of who gets merged with whom. Should we club together a few weak banks and write their obituary or should we push a weak bank down the throat of strong bank and make it weaker? Should we group the banks on the basis of where they are located or the profile of their assets? Of course, State Bank of India has already merged its associate banks with itself but that’s more of a family affair as they were virtually operating as one entity.

Wholesale And Retail Banks?

Also, there have been talks of saying goodbye to universal banking and regrouping the public sector banking industry on the basis of their balance sheet strength, asset profile and network. For instance, State Bank of India with its Rs32.36 trillion assets and 22,584 branches and close to 59,000 ATMs should continue to do what it has been doing—both wholesale and retail banking. Ditto about some of the other large banks, including Punjab National Bank (Rs7.32 trillion assets, 6,957 branches and 9,600 ATMs), Bank of Baroda (Rs6.77 trillion assets, 5,458 branches and over 10,000 ATMs) and a few others.

However, all PSBs do not need to do everything for every customer. Indian Bank (Rs2.3 trillion assets, 2,736 branches and 3,218 ATMs), Andhra Bank (Rs2.23 trillion assets, 2,912 branches and 3,990 ATMs) and a few others can focus only on retail banking while Vijaya Bank (Rs1.53 trillion assets, 2,136 branches and 2,209 ATMs), Dena Bank (Rs1.21 trillion assets, 1,872 branches and 1,678 ATMs), Punjab & Sind Bank (Rs1.04 trillion assets, 1,500 branches and 1,253 ATMs) and a few others can be converted into regional banks. They do not need to be present across India and dabble in every banking product. My understanding is that the government was seriously exploring this idea till the sudden spurt in high-value frauds derailed it.

Privatization: A Dirty Word?

As a test case, the government had some time back committed to privatize IDBI Bank but nothing has happened. The recent developments in two large private banks—Axis Bank Ltd and ICICI Bank Ltd—will delay it even further as privatization has become a dirty word in Indian banking. Every private bank in India is not well-governed and super-efficient, but there is no harm in giving it a shot.

To start with, the government can offer 26% stake in a couple of highly stressed banks to large Indian corporations with deep pockets and impeccable governance standards. A few such entities had applied for a banking licence when RBI opened the window in 2013, but withdrew from the race after studying the licensing norms that left nothing much on the table for the promoter in the long run. They have the money and the bandwidth, and some of them have been successfully running large non-banking financial companies. If they meet the so called “fit and proper” criterion, throw the challenge of turning around the weakest banks to them with right incentives.

If the experiment succeeds, the biggest beneficiary will be the government. It will be spared from pumping in capital in PSBs periodically to keep them afloat, beside booking handsome returns by selling its stake. The industry will benefit as the established private banks will face serious competition. Let’s do this.

Tamal Bandyopadhyay

Adviser, Strategy at Bandhan Bank Ltd, & Consulting Editor, Mint

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