The basic argument that Mr Patel has been making has its roots in the discourse on banking reform and reducing dominant state ownership and control over the banks. There is an assumption that state-owned banks have a sovereign guarantee and, therefore, safe from the depositors’ perspective. But sovereign ownership also creates a sense of performance complacence. The punishment by the stock market for non-performance is blunt but it does not ostensibly harm the dominant shareholder. It is the minority shareholder who suffers at the first instance and then (if the insulation of the sovereign is removed) the saver. However, if there is a large overlap between savers and tax payers then they are paying the price for saving themselves at one end even as the cost of finance for the economy does not go down. The cost of non-performing assets and administrative overheads ultimately has to be recovered from the profits — a reason he indicates that interest rate cuts do not get transmitted.
Mr Patel talked about the impossible trilemma in a keynote address in a presentation in Stanford, where he argued that if the banking sector is dominantly owned by the state and there was a limited fiscal space, then transgressions occur and what is essentially the domain of monetary intervention permeates the fiscal space. If the state itself announces “credit budgets” (giving directions and targets on where capital formation should take place but through commercial institutions controlled by it) then independent regulation suffers. The use of a commercial organisation that is not completely autonomous for ostensibly developmental objectives that may not fetch market returns would result in stress — and that is what we are seeing with the state-owned banks. This is a problem even if we do not have cronyism, but it is accentuated when that element is added to the mix.
One effective way to deal with this is to strengthen regulation. That cannot happen unless: (a) the regulatory framework is common for all players and GBs do not have a special cover from the sovereign; and (b) ownership (or the framework of governance) moves towards “autonomy” where the banks are accountable to the markets — not only for their performance but also for raising incremental capital. Without (b), it would be difficult to achieve (a).
Mr Patel has gone to the root of the problem and discusses it in great detail. The rest of the arguments are about setting things right. One could do this by intermediate measures of reform — create insularity between the state and the bank by having an independent authority to appoint senior management; empower boards; and empower the regulator to take actions that are no different from the leeway available for private banks.
These intermediate measures have been tried in bits and pieces at differing times. However, while we would see “reform” for a brief period, the “Empire (almost always) Strikes Back,” as Mr Patel puts it. So, this argument is not about privatisation or ownership but about having an appropriate accountability framework for the role and function of the entity that dictates the economy. If the ownership predicates the accountability framework, that needs to change. From past efforts at reform that seems to be the only way in which we do not relapse.
Is anybody listening? Well, they did not listen to the governor; would they listen to a former governor?
firstname.lastname@example.org; the reviewer is a faculty member and Chairperson of the Centre for Public Policy, IIM, Bangalore