Capital as reward for efficiency: Some public banks get a raw deal from govt

Ahead of the union budget for 2015-2016, the government has announced its plan to infuse part of the Rs 11,200 crore capital in state-run banks promised in the 2014-15 budget. In the first tranche, Rs 6,990 crore will be infused in nine public banks, which are deemed more efficient in terms of certain parameters such as return on assets and return on equity, if one goes by the official version. According to the criteria laid out by the government, the list of ‘performers’ would include State Bank of India (SBI), Punjab National Bank (PNB), Bank of Baroda (BoB) and Canara Bank, among others. SBI will get Rs 2,970 crore, followed by BoB Rs 1,260 crore, PNB Rs 870 crore and Canara Bank Rs 570 crore. The government will have to work out ways to release the remaining Rs 4,210 crore in the next one month to meet the annual budget target. Until now, the government used to divide the capital in various banks depending upon the size of operations. The new criteria to divide funds based on the efficiency parameters, would be a progressive step since this will push banks to improve their performance and stand ahead in the list of claimants for government funding. But, arguably, there is another, obvious, side to it. [caption id=“attachment_2088027” align=“alignleft” width=“380”] As part of the recapitalisation, SBI will get Rs 2,970 crore. Reuters[/caption] It is too early and somewhat illogical for the government to expect and insist upon certain operational efficiency standards from state-run banks and decide the share of capital infusion based on that evaluation before it reforms these banks. There are critical reforms needed in these banks across multiple areas to offer them a level-playing field with rivals in private sector. These include major overhaul in the areas of HR practices and autonomy in conducting business, flawed compensation policies and long-pending privatization agenda . At this stage, the government has only promised to bring in these reforms in state-run banks. It makes sense if the government is to evaluate state-run banks’ operations after the reform process happen and if, suppose, these entities fail to improve their business and efficiency. At present, all state-run banks carry the legacy of years of mismanagement, government intervention in their operations in the form of directed lending to specific high-risk sectors , roll out of politically motivated populist measures such as repeated loan waivers and financial inclusion plans, such as Jan Dhan Yojana, that are partly forced upon banks aren’t necessarily need- based and in line with the income standards of customers. While on the one hand, the government uses state-run banks according to its on whims, on the other it insists on improving efficiency. This wouldn’t make much sense. State-run banks should be given an operational environment to compete freely with private and foreign banks in a reformed framework. As of now, only bigger banks manage to show better efficiency parameters, hence received the larger chunk of government capital. What would this mean to other, small, ‘less efficient’ banks? Would they have to die a natural death in due course? Until now, the government has been silent on the privatisation of state-run banks, which is the only way to keep these entities in long-term when competition kicks in. While it still continues to be the owner of these lenders, the government cannot adopt a double standard to these lenders over the stronger ones. The present exercise of choosing the ‘performing’ nine banks for bigger share of capital and leaving the 18 other ‘non-performers’ to guess their fate, wouldn’t augur well in the eyes of investors and rating agencies, given that state-run lenders still continue to control 71 per cent of the industry. In fact, rating agencies have already sounded caution on the capital constraints faced by public banks. According to Fitch ratings, the ability of state-run banks to raise equity capital continues to be limited. “India’s state banks continue to be largely dependent on government for capital, while the large private banks are in a strong position to raise core equity capital directly through the markets,” Fitch said on Monday. Further, the agency has noted that public banks will continue to face challenges even after this round of capital infusion. “The ability to raise core equity Tier 1 (CET1) capital in the market is limited for many state banks, owing to below-book valuations alongside poor asset quality and earnings,” Fitch said. The idea of performance-based capital infusion is indeed a progressive step in the long term. According to Ananda Bhoumik, a senior director at India Ratings and Research, this would further curtail the credit expansion in these banks and “magnify” the negative effect of weakness on account of high bad loans, weak capital base and a slowing economy, plaguing the state-run banks.