Increased Foreign Investment Is Way Forward For Banking Reforms

The proposed hike in foreign investment limit in banks can reinforce the ongoing spate of bank reforms that are in progress at different stages. The increase, from 74 per cent to 100 per cent in private banks and from 20 per cent to 49 per cent in public sector banks (PSBs), can be an effective agent for transformation of the banking system. This assumes more significance at a time when a historic move for additional capital infusion of Rs 2.11 trillion is being contemplated. The first trench of Rs 80,000 crore, of the Rs 1.35 trillion of recapitalisation bonds, is set to be floated soon. While the proposed capital infusion will not only lift the capital adequacy ratio (CAR), it will also restore lending ability. The revised ownership after the enhancement of foreign investment limit in PSBs may resurrect the weak governance structure, the crux of protracted malady. The foreign investment can forge compatible structural changes, demanding better governance standards.

Reports indicate that the historic size of capital infusion, when seen together with change in ownership pattern, can be linked to the prospects of accelerated bank reforms. The seriousness for such seminal bank reforms was felt indispensable only after Reserve Bank of India initiated an asset quality review (AQR). After the capital infusion, if PSBs are able to restore their strategic position, an AQR to clean up balance sheets of banks will go in history as a game-changing strategy of the central bank. Without losing time, PSBs should now stand up to the challenge and gradually work towards overcoming weaknesses with concomitant internal reforms in the next three to five years.

Bank Reforms – Indradhanush

It can be recalled that the roll-out of the seven-pronged comprehensive bank reform plan under ‘Indradhanush’ is the first seminal move. Some of the key changes in the governance of PSBs, akin to private banks, can work well in the long run. Setting up of a Banks Board Bureau (BBB), separation of the positions of managing director, chief executive officer and chairman in PSBs are far-reaching changes intended to pursue long-term vision. The BBB began to bring independence and autonomy in the selection of board-level appointments in PSBs. The formation of Bank Investment Company (BIC) as a holding company to route capital, thus bringing down government interference in the functioning of PSBs, is yet to be implemented.

Asset Quality Challenges

With the removal of veil on non-performing assets (NPAs), banks began to recognise the hitherto suppressed menace. Under the impact of such crowding of bad loans, the net worth of many small and medium PSBs turned negative. As a result, the stressed assets of Scheduled Commercial Banks (SCBs) climbed to a high of 12.2 per cent, whereas in the case of PSBs, it reached a high of 16.2 per cent by September 2017. More stress is waiting with 56 per cent of large advances (Rs 5 crore and above) still struggling in the category of Special Mention Accounts 2 (SMA2) with overdues stretching beyond 60 days.

The dual impact of a fall in net interest margin (NIM) due to a surge in newly recognised bad loans and rise in provision requirements, many PSBs sustained losses, breaking their profit-making record maintained since nationalisation. It turned return on assets (ROA) and earnings per share (EPS) negative, losing market sheen. The rise in risk-weighted assets without any plough-back of profits during the years reduced capital adequacy ratio (CAR) too, capping the ability to lend. Erosion of fundamentals led to RBI imposing prompt corrective action (PCA) on many small/medium-sized PSBs, including Bank of India, a large one.

Strengthening Asset Quality

This is despite RBI implementing enhanced systemic controls through its ‘Framework to revitalise the distressed assets in the economy’ in January 2014. The key tools for toning up asset quality includes (i) time-bound formation of joint lenders forum (JLF), sensing early signs of delinquency; (ii) creation of Central Repository of Information on Large Credit (CRILC) for loans of Rs 5 crore and above; (iii) ‘Non cooperative borrower’; and (iv) wilful defaulters.

The Insolvency and Bankruptcy Code (IBC) 2016, with its two subsequent amendments, is also expected to aid quicker debt resolution. The new measures are now intended to improve the loan repayment culture. The complacency of large borrowers that banks would accommodate additional sanctions even if overdues are not serviced in time to protect asset quality, will be waning fast. The fear of losing control on the unit under the IBC framework will dissuade such tendency.

With a historic thrust on bank reforms, when seen together with initiatives to change the ownership structure, PSBs can be on a faster recovery mode, provided they can quickly adapt to a better performance management system focused on result and growth orientation. The performance-neutral pay and perquisites is the bane of PSBs, where talent cannot be rewarded. The incentive for good work and disincentive for lacklustre performance is the crux of weakness of PSBs. In this context, the recent views of Dr Vinod Rai, chief of BBB, about differential pay and perquisites in PSBs from the next financial year, if implemented, can hasten recovery. Hence, the proposed increase in foreign investment in banks, if approved, can be an effective reinforcing agent to bring about the desired transformation in banking sector, more pointed towards PSBs. Ownership can be a critical factor only if it can influence the change in governance of PSBs, which has been struggling in the midst of dichotomy of interference and professional autonomy, since nationalisation.