Banking: Where do we go from here?

The gross non-performing assets (NPAs) ratio of scheduled commercial banks has declined from 11.5% in March 2018 to 10.8% in September 2018

We have entered 2019 with the banking sector still in distress. True, there are signs of improvement. The gross non-performing assets (NPAs) ratio of scheduled commercial banks has declined from 11.5 per cent in March 2018 to 10.8 per cent in September 2018. The Reserve Bank of India (RBI) expects the ratio to decline further to 10.3 per cent in March 2019.

 

That does not mean the sector is out of the woods. There is no dearth of businesses that can pose shocks in the year ahead — telecom, aviation, non-banking financial companies (NBFCs), small and medium enterprises (SMEs). We would be lucky if the sector were to return to normalcy by the end of 2020.

 

In retrospect, the primary reason that the crisis has proved protracted should be clear enough. It is the failure to recapitalise public sector banks (PSBs) adequately and early enough. Once the RBI started tightening its norms for NPAs under its asset quality review in December 2015, NPAs started shooting up. The government should have moved swiftly to provide the PSBs with capital to cover provisions as well as growth in credit.

 

That did not happen. In August 2015, the government had announced an infusion of Rs 70,000 crore over a four year period. Thereafter, it was only in October 2017 that the government announced a further infusion of Rs 1.35 trillion. This infusion, too, will happen over a period.

 

There is a world of difference between providing enough capital at one go and providing it in instalments. When capital is provided at one go, there is enough to cover losses and to finance credit growth. Growth in credit, in turn, creates profit that can be ploughed back into capital.

 

When the same capital is provided in instalments, it goes mostly towards covering losses.  Credit growth is tardy. Banks and borrowers are both adversely impacted, making things worse. This is precisely what has happened. The RBI’s latest Trend and Progress in Banking notes that more than 70 per cent of the capital infused was absorbed into losses incurred by banks, leaving little for credit growth.

 

Commentators never tire of saying that, without governance reforms at PSBs, recapitalisation is ‘money down the drain’. Well, the infusion of capital is happening in instalments anyway without the governance reforms that many have urged. There was little to be lost, therefore, in infusing the same capital upfront. Dithering on bank recapitalisation has proved costly for the economy.

 

Where do we go from here? We need measures that are politically feasible, not ones that commentators think are ideal. The recent report of Parliament’s Standing Committee on Finance is a guide to what is feasible. The Committee was chaired by Congress leader Veerappa Moily and it comprised members drawn from many political parties. What does the Committee have to say?

 

First, the Committee does not believe that privatisation of PSBs is the solution — the present crisis, the Committee believes, is “transient”.

 

Secondly, on two issues on which the government has had differences with the RBI, the Committee supports the government’s position. The Committee thinks it important to suspend RBI’s capital adequacy requirement for banks, which is one per cent higher than that stipulated under the Basel norms. The Committee also wants the RBI to provide a roadmap for the 11 banks covered under Prompt Corrective Action (PCA) to come out of the framework as quickly as possible. 

 

The RBI’s latest Trend and Progress sticks to the RBI’s stated position on both counts. It contends that the cumulative default rates and the losses given default are higher in the Indian context. But this is an argument for applying higher risk weights to the loans in question. It does not imply that the minimum capital requirement should go up.

 

The RBI also argues that provisions made by Indian banks are inadequate, hence higher capital buffers are appropriate. It makes the same argument for having a PCA regime that is more stringent than elsewhere. If the RBI’s concern is that, in the event of losses, the required top-up of capital at PSBs may not happen quickly enough, there is a way of addressing it.

 

Let the RBI enter into a Memorandum of Understanding (MoU) with the government of India. The MoU should lay down that the RBI will reduce the capital requirement for banks to the Basel minimum on the understanding that the government undertakes to meet the minimum capital requirement of PSBs within, say, three months of capital dipping below it. Such an MoU should help resolve the present impasse. 

 

The Committee proposes several reforms. Development financial institutions need to be revived. The RBI’s powers to regulate PSBs may be reviewed. At PSBs, there must be promotions from within the bank to the posts of executive director and managing director. Incentives and remuneration for senior management at PSBs must be improved. PSB boards need to be professionalised and empowered. The Committee wants an appraisal of whether the RBI has adequately exercised its authority in respect of “digressions” by private banks such as ICICI Bank. Finance ministry, please note.

 

This is the political class as a whole speaking. And it’s saying that there are many sensible reforms that can happen within the existing framework of government ownership. Is the commentariat listening? The writer is a professor at IIM Ahmedabad.

Email:  ttr@iima.ac.in