RBI governor is correct in demanding more powers over PSBs, says Montek

"The (PNB) fraud by itself cannot be an argument for privatisation. We have seen frauds in even the most sophisticated private banking systems in the West"

Former Planning Commission deputy chairman Montek Singh Ahluwalia favours diluting the Centre’s stake in select public sector banks (PSBs) to below 50 per cent. However, he tells Indivjal Dhasmana that the case for privatising PSBs is independent of the Punjab National Bank (PNB) fraud. He favours abolishing the banking division to avoid micromanagement by the government and says PSBs need flexibility if they are to compete effectively. Edited excerpts:

Following the fraud at PNB, the demand for the privatisation of banks is increasing. What is your take on this?

The fraud by itself cannot be an argument for privatisation. We have seen frauds in even the most sophisticated private banking systems in the West. Frauds will occur, but we can reduce the likelihood of fraud and ensure early detection through better internal and external controls. This is where our system failed. The PNB fraud went on for several years.

The Reserve Bank of India (RBI) governor has said that the RBI had warned all banks to ensure linkage of SWIFT messaging with the Core Banking System. An obvious question is whether the RBI followed up on this advice and checked on compliance in its annual reviews. There are RBI directors on the board of every PSB. Were they aware of this advice and did they ask managements to report on compliance to the board? All this will come out as the investigations proceed.

The real case for privatisation is that it will enable the banks to function efficiently as commercial enterprises, without micromanagement by the finance ministry. Micromanagement itself arises because of the dual regulation to which PSBs are subject — one by the RBI and the other by the banking division in the finance ministry. Dual regulation and privatisation are two separate issues. In principle, one could get rid of dual regulation and still not do anything about privatisation.

What is the problem in dual regulation?  

The problem arises because the RBI does not have the same powers of oversight and control over PSBs as it does for private sector banks. It can remove the chief executives and board members, and indeed replace the entire board, in the case of a private sector bank, but not a PSB. The fact that PSBs are not fully regulated by the RBI led to the enhanced oversight by the ministry. I agree with RBI Governor Urjit Patel that the RBI should have the same powers for PSBs. Once this is done, there will be no need for the banking division to do a second layer of regulation. This would be true even if the government retains a majority stake. The first Narasimham Committee report in 1991 did not recommend privatisation, but it had a separate note signed by two members, Manu Shroff and Mrinal Datta Chaudhary, recommending the abolition of the banking division to get rid of dual regulation. Shroff had served for several years as additional secretary (banking), so his was an expert opinion! If the banks are privatised, there is no need for banking division oversight.

There are various models of privatisation. Which one do you prefer?

Let us distinguish between two types of privatisation. One would involve reducing the government shareholding below 50 per cent, but still leave the government as a substantial shareholder. The other would involve handing over all the equity to a private party that meets the RBI’s “fit and proper” norms. I do not think a complete handing over is politically feasible or even desirable. However, I think the time has come to reduce the government’s stake below 50 per cent to, say, 33 per cent. This was recommended by the second Narasimham Committee in 1998 and Yashwant Sinha (as finance minister) even said in Parliament that he would do it, but he could not get his party to back him.

There will be political opposition but we must start building a sufficient consensus in favour of this move. It should be explained that with a 33 per cent stake, the government can ensure that social obligations, such as targets for lending to agriculture or to small-scale industry, will continue. The relevant laws will have to be changed to permit a reduction below 50 per cent and these would apply to all banks. However, we need not take up all banks. We could leave State Bank of India alone to begin with, and take up the dilution for some others.

The PJ Nayak Committee had suggested setting up a banking investment company. Will this solve the problem?

The Nayak Committee suggested this because it thought privatisation would not be politically acceptable. It viewed it as a way of distancing the government from the management of the banks. It envisaged the government holding a majority stake but transferring it to an investment company which, as the new majority owner, would appoint members on the board and also top managers. The investment company would then be responsible to the government for the performance of the banks on some agreed parameters. In this scheme, the banking division would cease to have any direct connection with individual banks.

It is a good idea in principle but I do not think it will work if the government retains a majority stake. It is very difficult for a government to hold a majority stake and to distance itself from operations.

What would be the gain if the government’s equity went below 50 per cent?

The banks would no longer be legally bound by rules that apply to public sector undertakings. The chief economic advisor has rightly pointed out that public sector banks are not free to take decisions because they have to worry about three Cs: The Central Vigilance Commission, the Central Bureau of Investigation, and the Comptroller and Auditor General. With the government holding more than 50 per cent, bank managers are treated as “public servants” under the Prevention of Corruption Act. Under this Act, a public servant can be held guilty of corruption if an action taken by him or her “obtains something of value” for a private person without the public interest being served. There is no definition of public interest. Granting loans is clearly giving something of value. So is debt restructuring. The environment is worsening because of the pervasive lack of trust. Anyone can make an accusation, which would start an investigative process. Naturally, bank managers prefer not to take decisions or create elaborate processes whereby proposals are processed through multiple layers. The result is delay and inaction. The seriousness of this problem is not well understood.

Banking technology is changing rapidly and PSBs need to be nimble to compete with private sector banks. If we don’t give them flexibility they will simply lose market share. Their share of assets at present is 70 per cent. Private banks are growing much faster. The market share of PSBs could go down below 50 per cent in 10 years. We will end up privatising the banking sector, while resisting the privatisation of individual banks. It makes no sense.