Why The Modi Approach To Rescuing Public Sector Banks Will Not Work

by R Jagannathan - Oct 13, 2016 11:39 AM +05:30 IST
Why The Modi Approach To Rescuing Public Sector Banks Will Not WorkNarendra Modi
  • That the Narendra Modi government has kept political interference in bank lending away has helped, but the solution does not lie in having an incorruptible Prime Minister, but in fixing an institutional failure.

The worst should be over for public sector (PSU) banks over the next quarter or two, thanks to a benign interest rate regime and the Reserve Bank of India’s (RBI) more accommodating stance on bad loans already on their books. An economic revival by the end of this year will also help banks report a reduction in gross non-performing assets (NPAs) – a figure edging towards Rs 500,000 crore, almost double the levels in March 2015.

That the Narendra Modi government has kept political interference in bank lending away has helped, but the solution does not lie in having an incorruptible Prime Minister, but in fixing an institutional failure. Modi has not really attempted to fix this, committed as he is to the flawed belief that the public sector can do much better even in the current structure of majority government ownership. Getting better managers or giving them more autonomy will not provide a cure – just as swallowing cough drops will not treat throat cancer.

Though Modi has gone some way in improving governance in PSU banking, including by creating the Bank Board Bureau under former CAG Vinod Rai to insulate bank managements from excessive fear of corruption probes, the fact is top bank managers are reluctant to really govern and fix problems.

Rai, whose interview was published by The Economic Times today (13 October), has gone on record to say that public sector banks are simply not doing enough to recover or sell bad loans despite a conducive atmosphere for it. He said: “We are not making much progress and I don’t think we have anybody else to blame but the banks themselves... The critical issue… in FY16-17 (is), how many bad loans have you resolved?” He added, for good measure: “I don’t think at any point of time before this, the government or RBI had made it so simple for them to settle. But the point is RBI is not going to lay out the entire red carpet and then say you settle.”

As the old proverb goes, you can take a horse to the river, but you cannot make it drink. The critical question Rai, and Narendra Modi and Arun Jaitley, need to ask themselves is this: why aren’t bankers doing what needs to be done despite being given the right environment for doing so?

Let’s be clear. Public sector banking is not in deep trouble because it lacks talent or even autonomy; it is never going to perform as well as the private sector because of a flawed institutional structure of accountability and a skewed performance incentive structure.

The first failure is lack of long-term accountability and ownership of the institution. Even though public sector bankers are typically those who have spent decades in their banks, they are not encouraged to take risks and rewarded when they take the right calls. Nor are they penalised for terrible decisions as long as they have followed rules. So where is the incentive to perform?

The average tenure of public sector bank chairmen or chief executives is short – five years at the outer limit, which OP Bhatt got at State Bank of India (SBI). But he didn’t fundamentally change the organisation. The current chair, Arundhati Bhattacharya, got three years, and a year’s extension now to see the mergers of its subsidiaries through. To fix SBI, you need a tenure of seven to 10 years, for that’s how deep the institutional culture of non-risk-taking runs. And we know Bhattacharya won’t get that.

Now consider how long current private bank chief executives have been at the helm: Chanda Kochhar of ICICI Bank (seven years and counting); Shikha Sharma at Axis Bank (seven years and counting); Romesh Sobti at IndusInd Bank (nine years and counting); and the big daddy of them all, Aditya Puri at HDFC Bank (22 years and counting). Is it any surprise that these bankers act like long-term owners and have propelled their banks to fantastic valuations? HDFC Bank’s valuations are almost equal to that of the entire public sector banking industry.

Tenure and accountability ensure a closer linkage between performance and rewards; between risks taken and results delivered. On the other hand, the benefits of good work done by a public sector banker accrues not during his tenure, but during that of his successors. PSU bankers have, thus, perfected a technique of gaming the system: when a new chairman is appointed, he usually reports a big drop in profits in his first quarter, so that a large chunk of bad loans is accounted for. He can indirectly point to the previous incumbent as the man (or woman) who created the problem and even gets kudos for being brave enough to attempt cleaning up the mess; but he does not carry the process through till the last, for by the time the balance-sheet starts responding to his ministrations, it is time for him to leave.

A case in point is Pratip Chaudhuri, who succeeded OP Bhatt as chairman of SBI in early 2011. Soon after taking over, he reported a 99 percent drop in net profits in his very first quarter (January-March 2011). But by the time he had to leave in September 2013, the economy was tanking under the economic mismanagement of the United Progressive Alliance government, and Chaudhuri got no profit lift to receive a warmer sendoff despite his early efforts to fix the bad loan problem.

This rigmarole has been repeated in many other public sector banks too. The simple takeout: public sector bankers have no reason to go the extra mile to deliver. In fact, they may be penalised, either by the markets or their political masters, for it. When Chaudhuri reported huge losses in his initial quarters, the Finance Ministry, then under Pranab Mukherjee, wanted to check if SBI was over-providing for bad loans! So much for rewarding good work.

Coming to Rai’s point that PSU banks are not doing enough to go after bad loans, let’s picture this scenario. Let’s assume that both government and the Bank Board Bureau want you to clean up your books. You are the chairman, or a senior executive director, who has one or two years to retire. You are probably going to need a post-retirement job as adviser or consultant somewhere. You can, if you want, chase all the crony capitalists to the end of the earth while you are chairman, but the courts will delay the process endlessly. As retirement looms, are you more likely to seek private sector benefactors who will pay offer you a sinecure, or do your job as prescribed in the Bhagavad Gita: doing your duty without looking for rewards. The odd chairman or two may do so; the rest will succumb to pressure and enticements from the private sector to not chase loans too diligently. Not chasing a loan will not count as a negative against you; going for it will mark you out as unemployable in the private sector. Who then will chase bad loans?

Now consider the case of Chanda Kochhar of ICICI Bank. She knows her reputation depends on her going after bad loans, and she also knows that her shareholders will not hold it against her if she gets bad loans off her books by taking a haircut. This is why she bravely got rid of her Kingfisher loans (Rs 430 crore of it) by selling it to SREI Infra for a discount. The public sector banks, which held on to the bulk of the Kingfisher loans of over Rs 7,000 crore, were frozen in inaction. (To find out how SREI itself managed to make its Kingfisher loan purchase pay, read this story here). If any public sector banker had tried breaking ranks with the roster of bankers who held Kingfisher debts, they would have been investigated for alleged corruption. There would have been whispers of backroom deals.

The moral of the story is simple: the incentive and accountability structures in public sector banking is seriously flawed, and no Bank Board Bureau can change this.

Modi has to do it, and the only way out is gradual privatisation and induction of accountable bosses with longer tenures tied to long-term performance and profitability.

By retaining a strong public sector banking presence, the government is doing no one any favours. It is destroying the taxpayer wealth embedded in PSU banks – what’s left of it.

Jagannathan is Editorial Director, Swarajya. He tweets at @TheJaggi.
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