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Mergers of public sector banks favoured

Rakesh Mohan
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The financial sector assessment report, prepared by the Reserve Bank of India (RBI) and the Central Government, has favoured the merger of public sector banks (PSBs) having a government holding bordering on 51 per cent with those having a much higher state-holding to ensure that their business growth does not suffer due to capital constraints.

If the government is not able to contribute its share of the capital needed for the growth of the public sector banking system, it will need to reduce its share holding below 51 per cent. This requires legislative changes, the report, which was released on Monday, said.

“However, pending enactments of enabling legislation to reduce majority ownership, and keeping in mind the synergies, one option for the government could be to consider amalgamating banks,” it added. It emphasised that such mergers should be considered only when there was positive synergy and complementarity in the regional spread among the banks proposed to be amalgamated.

The report indicated that PSBs would need additional capital to meet Basel II norms and maintain an asset growth for the overall projected growth of the economy at 8 per cent and consequent growth of risk-weighted assets (RWAs).

This has the potential to further aggravate a growing apprehension that public sector banks’ growth could be constrained in relation to other players.

The extent of additional capital required from the government is expected to be manageable, provided the RWAs grow by within 25 per cent annually and total cost of recapitalisation would be lower than in most other countries.

The government has already announced plans to infuse capital worth Rs 20,000 crore over two years in public sector banks to maintain a comfortable capital adequacy ratio of 12 per cent. Some of the banks, including Central Bank of India and Vijaya Bank, have already received the first tranche of capital. Referring to monitoring of state-owned banks, the report said any suggestion that the government must exit its monitoring function of these entities and leave governance entirely to a duly-constituted board was unrealistic in the present environment.

Such a move might be undesirable as well. A reduction in the government’s majority shareholding would also enable the public sector banks to retain and attract talent as, in that case, their incentive structure would not be limited by the government pay structure.
 

The Pros and Cons of Public Sector Banks in India

PROS
* Given their public sector nature, it augurs well for financial stability as these institutions enjoy implicit government guarantee.
* The economy has been able to realise certain social objectives through these institutions by enforcing provisions related to spreading the reach of banking in the country through these institutions.
* PSBs have been active agents in promoting financial inclusion.
* Given the spread of these institutions, they have been able to tap and mobilise retail deposits.
* Given their spread, they have been able to fund the requirements of small and marginal farmers as also other SMEs.
CONS
* The functioning of PSBs is often subject to inflexible and, at times, dated rules. The layered decision-making process and uniformity in rules across the banks could impinge on their flexibility in operations. The stringent CVC guidelines, which the PSBs are subjected to, make it difficult for them to innovate and compete with the private sector and foreign banks who enjoy relatively greater flexibility in operations.
* HR issues, such as development of core competence, appropriate and market-related incentive structure, and attractive career paths make it difficult for PSBs to attract and retain talent. The productivity of human capital, which is measured in terms of business per employee, is observed to be lower in PSBs than in private and foreign banks, though this could be attributed to the larger spread of PSBs.

The report advocated the urgent need for an upward revision of the remuneration and incentive structure of the public sector banks that would be commensurate with responsibility and more in alignment with the changing times.

“At the same time, there is a need to ensure that the incentives for the top management and key executives are monitored and linked to their performance over a longer term economic cycle,” the report said.

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