Banking on the Union Budget

In the run up to the Union Budget, all industry bodies reach out to the North Block with their agenda. For the banking industry, this annual ritual,  typically focuses on the unlevel playing field vis-à-vis mutual funds and the government savings schemes. Banks find it difficult to bring down the interest rates on deposits for fear of losing out to the mutual fund schemes that offer certain tax benefits and the high-yield government savings schemes. Ahead of this Budget, the government has cut the interest rates on small savings schemes and the market regulator’s new rule may force corporations to move part of their funds from mutual funds to banks.


So, what should Finance Minister Nirmala Sitharaman do for the banking sector? Here are a few suggestions —not exactly unsolicited as she had asked for them on Twitter. While keeping the tradition of meeting the industry lobby groups and economists alive, the Bharatiya Janata Party-led National Democratic Alliance (NDA) government has started crowdsourcing inputs for Budget since 2016. I have missed the deadline for submission of such suggestions but am still joining the crowd.


For quite some time, the talking point at the cocktail circuit has been the risk averseness of the public sector banks (PSBs) — they don’t want to give loans. The root of it is a fear psychosis. The investigative agencies have been hounding senior bankers and barring an odd case of the CEO of a private bank, they are particularly aggressive when it comes to officials of the government-owned banks.


Quite a few of them have been arrested and many more questioned but there has not been a single instance of a public sector banker being prosecuted for mala fide decisions on giving loans or settling the dues of a defaulter. The fear is slowing down both lending as well as recovery of bad loans. It’s time to instil confidence in these bankers who run close to 70 per cent of the industry. Indeed, the guilty should be punished but just based on allegations they should not be harassed and their reputation sacrificed.


While bankers at the senior level should be under strict surveillance, they also need to be rewarded suitably. Let’s delink the salary structure of PSB chiefs from that of the civil servants as their job profiles are different. And, there should be incentives for performers. The employee stock options proposals of at least two banks — State Bank of India and Bank of Baroda — have been gathering dust in the North Block for years now.


A strong banking system is imperative for economic growth and the bad loan-laden PSBs cannot play a meaningful role. The recent crisis in the non-banking finance sector has intensified the problem and many banks are staring at potential fresh non-performing assets. The traditional tool to tackle this has been infusion of capital into these banks. Historically, the government has pumped in Rs 3.5 trillion, a bulk of which (some Rs 3.3 trillion) has come in since 2009.


In the past two years alone, the government has infused close to Rs 2 trillion to keep the ailing PSBs afloat. For the record, since fiscal year 2016 when the Reserve Bank of India introduced the so-called asset quality review (AQR) to clean up banks’ balance sheets, the PSBs have made net losses of Rs 1.78 trillion. In the five years of the NDA rule, between financial year 2015 and 2019, the PSBs made losses in three years, and the profits made in two years is less than Rs 35,000 crore.


The reason for the huge losses is over Rs 9.2 trillion provisions that these banks needed to do in these five years to take care of their bad loans. The gross bad loans of the PSBs that were Rs 2.62 trillion in 2015, jumped to Rs 5.16 trillion the very next year following the AQR, and Rs 8.96 trillion in 2018, before sliding to Rs 7.68 trillion in 2019. Two PSBs now have at least one-fourth of their loan assets stinking; for one of them, bad loans are at least 20 per cent of the loan book; and for nine, at least 15 per cent. The growth in interest income is muted as many of these banks are not able to give fresh loans. While net losses have zoomed in the past five years because of bloated provision requirement, their net interest income has risen progressively from Rs 1.81 trillion in 2015 to Rs 2.3 trillion in 2019.


Should the government continue to own all these banks? Is consolidation the panacea? Former finance minister Arun Jaitley had committed to privatising the sick IDBI Bank and this has been done. The government is no longer the majority owner of this bank. Life Insurance Corporation of India has stepped in as the new owner. Is this privatisation? The consolidation drive started with merging the associate banks with the nation’s largest lender, the State Bank of India. While that was a sort of family affair, the merger of two PSBs with Bank of Baroda demonstrates the seriousness of the government’s intent. Will this solve the problem? Do we need so many PSBs? Can all of them be merged into different groups to form large banks?


A panel has recommended creation of a holding company for all PSBs by transferring the government’s stake to it to run them efficiently and create value. Recent media reports suggest that this proposal has been revived. This may not work as it’s difficult for the government to give up its control. The best solution is amending the Banking Act that says the government must hold at least 51 per cent of the paid-up capital in such banks and privatise a few of them.


Some of the weak banks have rotten balance sheets but they are great liability franchises. That's a perfect match for some of the troubled non-banking finance companies (NBFCs) that have been suffering from acute liquidity problem, which is threatening to affect their solvency. Why not auction some of the weak banks to the highest bidders? Of course, the prospective buyers must meet the so-called fit and proper criterion for owning and running a bank.


The government can make money selling even weak banks as the distressed NBFCs need robust liability-raising network and the money generated can be pumped into the not-so-weak banks to nurse them back to health. Done this way, the PSB recapitalisation will not have any impact on the fiscal deficit.


This is a bold idea but for a government that embraced demonetisation, it could be a cakewalk.


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