Debashis Basu: 3 problems with 7-point Indradhanush

On the eve of Independence Day, the government launched Indradhanush, a seven-point programme to rejuvenate public sector banks (PSBs). These cover better senior appointments, setting up a Bank Boards Bureau, pumping in more capital, reducing bad loans, empowering the management, improving accountability and better governance. However, would these changes rapidly deliver what we really need: a competitive, profitable and customer-friendly banking sector? As I see it, there are three major problems with the Indradhanush idea.

1. Where is RBI in this? The Ministry of Finance must be buzzing with activity, the likes of which we have not seen in many years. It is taking the lead in every banking and financial initiative: from a massive effort to bring the unbanked into the banking fold, to MUDRA Bank, to insurance schemes and now to Indradhanush. In the press conference announcing the details of Indradhanush, there were two ministers, a secretary and the economic advisor. The Reserve Bank of India (RBI) was conspicuous by its absence. The RBI has a large team of experts with a role in framing banking policies, implementation of plans, banking supervision and senior appointments. It is tasked with administering the Banking Regulations Act. But RBI does not seem to be involved in the far-reaching changes being contemplated for the banking sector.

The RBI governor, of course, will be heading the Bank Boards Bureau (BBB), which would soon begin the selection of its members. BBB itself would be an "interim arrangement" until the government sets up a holding company, which will hold all the government stakes in banks and "may take over some of the government's current role in their management." The Department of Banking Regulation, which is involved in policy making, is one of the two large departments of the RBI that oversee banks. Yet, it has failed to create a competitive banking sector, allowing customers the freedom to change their banks easily. Note that the first new bank in 12 years, Bandhan, was inaugurated yesterday. The Department of Banking Supervision oversees the operations of banks through hundreds of compliance reports but has been ineffective in stopping the way PSBs sanction loans that turn bad. Along with Indradhanush, there was a need for streamlining the role and responsibilities of the RBI, which influence the quality of banking operations in PSBs.

2. Half-measures: Politicians who have just assumed power and bureaucrats who take fresh charge, bring in a sense of natural confidence to their jobs. Often this confidence may lead to cherry-picking from the work that experts may have already done, or worse, ignoring it. In May 2014, the Narendra Modi government came to power. The same month, the PJ Nayak Committee (Committee to Review Governance of Boards of Banks in India) submitted its report to the RBI. The report, produced after talking to a large number of experts including successful PSB bankers and private banks, was widely hailed as a fine roadmap for PSB reform. The current government has not picked up anything much from that report.

The core problem with PSBs, as the Nayak committee saw it, is this: "Governance difficulties in public sector banks arise from several externally imposed constraints. These include dual regulation, by the Finance Ministry in addition to RBI; board constitution; significant and widening compensation differences with private sector banks; external vigilance enforcement though the CVC and CBI…"

The solution suggested by the committee was this: "If the Government stake in these banks were to reduce to less than 50 per cent, together with certain other executive measures taken, all these external constraints would disappear. This would be a beneficial trade-off for the Government because it would continue to be the dominant shareholder and, without its control in banks diminishing, it would create the conditions for its banks to compete more successfully. It is a fundamental irony that presently the Government disadvantages the very banks it has invested in." Indradhanush skirts this core problem and does not come anywhere near this elegant solution.

3. Platitudes: Indradhanush is a seven-point programme. The government has acted on just two things that were easy to do and have little connection to the core problems that beset PSUs: one, some top-level appointments, two, more capital. The third, BBB, is still to be worked upon. Four other points of the Indradhanush look rather woolly: reducing bad loans, empowering managements, improving accountability and better governance. These objectives have been discussed and debated by many committees in the past. Each government has been conceited enough think that it can set things right. Instead of trying to set things right, we should have a system that automatically prevents wrong things from happening. This is precisely why the Nayak committee had suggested that the government bring down its stakes, which would eliminate a host of issues, automatically. Quite the opposite is happening - government stakes are going up in the process of recapitalisation.

The writer is the editor of www.moneylife.in
Twitter: @Moneylifers