What does India’s new Reserve Bank of India (RBI) governor designate Urjit Patel thinks about the larger reforms issues in the country’s financial sector beyond matters of monetary policy (which is well known). Ever since he joined RBI as one of the deputy governors in January 2013, Patel hasn’t spoken much at public platforms. But, a 2003 paper jointly authored by Saugata Bhattacharya and Urjit R. Patel, then executive vice president of Infrastructure Development Finance Company and titled as ‘Reforms strategies in the Indian financial sector’, gives one interesting insights about his views on various issues concerning financial sector reforms.
The paper was presented at the conference on ‘India’s and China’s Experience with Reform and Growth’, organized by International Monetary Fund and National Council of Applied Economic Research in New Delhi. Though the paper is 13-years old, the views on some of the issues are very much relevant even today in the backdrop of Patel’s elevation to RBI governor’s role.
Corporate ownership in banks
It is interesting to note that Patel’s joint paper argued strongly in favor of corporate promoters owning more than 10 percent stake in private banks they float, contradictory to what RBI’s stance is today on this issue. The central bank, in its guidelines on on-tap bank licensing in the sector, has stipulated that industrial houses cannot have more than 10 percent stake in new private banks. “In order to prevent connected lending (one of the original motives for bank nationalisation), private banks in India cannot have corporate owners who own more than 10 percent of the bank’s equity capital. Precluding this route could constrain the ability of (some new private sector) banks to expand networks and offer more services” the paper said.
In its recent on–tap bank licensing guidelines, RBI has said that ‘large industrial houses are excluded as eligible entities but are permitted to invest in the banks up to 10 percent’, thus pouring ice-cold water on the plans of corporate tycoons, who want to wear the cap of a banker and control it. The RBI doesn’t want to take chances of private corporations misusing that money for related party lending.
Also, Patel’s paper argued against the attempts to mix commercial and social objectives (for instance, rural bank branch requirements) for private banks saying it will serve to increase the costs of intermediation, again something RBI has stipulated as a necessary condition for new bank entrants in the later years. In the latest guidelines too, banks have been asked to open at leas 25 percent of their branches in rural areas of the country.
Patel’s paper makes a strong pitch for privatisation of public sector banks. “The system of intermediation will not improve appreciably in the absence of any serious steps towards changing incentives blunted by public sector involvement (of which ownership is an important aspect). To sharpen these incentives, outright privatisation may not be sufficient, but it is necessary,” the paper said. So far, the Narendra Modi government has refused to seriously take up the task of privatisation of public sector banks, except in some cases like IDBI Bank, also due to the trade union resistance. Presently, the government owns stakes even up to 80 percent in some of these banks.
Another important question Patel-Bhattacharya makes in the paper is about the ownership of the government in banks and the logic of continuous recaptalisation of public sector banks. “While selective regulatory forbearance might be justified as a measure designed to balance the likely panic following news of runs on troubled institutions, a blanket guarantee by government makes forbearance difficult to calibrate and has the effect of sharply increasing system-wide moral hazard,” the paper said.
As for recapitalisation of nationalised banks, Patel’s paper said the idea made sense in the initial stages but cannot continue forever. “The large fiscally-funded recapitalisations of banks in the early and mid-nineties may be rationalised as being designed to prevent a system-wide collapse at a time when the sector had been buffeted by the onset of reforms and it had not had time to develop risk mitigation systems. Moreover, the overall reforms were designed to enhance domestic and external competition, as a result of which past loans to industry were bound to get adversely affected, impacting these banks’ balance sheets,” But “It needs to be recognised that the only sustainable method of ensuring capital adequacy in the long run is through improvement in earnings profile, not government recapitalisation or even mobilisation of private capital from the market,” the paper said.
One needs to see this statement in the context of massive recapitalisation exercise in government banks going on even today. In the past nine years, the government has infused Rs 1.18 lakh crore in these PSBs, with country’s largest lender, State Bank of India (SBI) getting the largest pie. Capital infusion in state-run banks continues as an annual ritual since these lenders are unable to generate the capital needed for them on their own. The spike in bad loans of certain lenders such as Indian Overseas Bank, whose bad loans have crossed 20 percent, requires much more than the regular capital infusion. Presently, there are at least four more state-run banks with NPAs above 10 percent. These are United Bank of India (14.29 percent), Punjab National Bank (13.75 percent), Andhra Bank (10.30 percent) and Union Bank of India (10.16 percent). The higher the bad loans the more the capital requirement from the government.
Social sector lending
The paper pinpoints “the policy of directed and priority sector lending” as major reason for contributing to the Non-performing Asset (NPA) pile. “In light of the numbers on the sector-wise origins of NPAs, as of end-March 2002, the notion of directed lending being the primary culprit may need to be nuanced (even if just a little)." While the share of priority sector NPAs in the total is about 40 percent, it should be noted that total loans outstanding to the priority sector (as a percentage of total loans) at end-March 2001 was about 34 percent.
One must note that even today, the ratio is around the same with priority sector loans contributing to Rs 22.58 lakh crore compared with the total loan outstanding of Rs 66.29 lakh crore. “The share of priority sector loans (i.e., directed credit to targeted sectors) of public sector banks (PSBs) in their bank credit has consistently remained above those of private and foreign banks and, since 1995-96, has also been above the statutory floor,” said the paper.
Also, the paper notes that banks have repeatedly been used by the government as quasi-fiscal instruments, including de facto sovereign borrowings for shoring up forex reserves. “It is well known, moreover, that the SBI is often used by the central bank as an indirect conduit for managing exchange rates,” the paper said. It is interesting to see in his new role as RBI governor, succeeding Raghuram Rajan, how Patel will approach the issues of banking sector reforms, including the issues mentioned above, considering his earlier stance reflected in this 2003 joint paper.