Free the banks

Mergers are cosmetic without real governance reform

Union Finance Minister Nirmala Sitharaman on Friday announced that the government planned to merge 10 public sector banks (PSBs) into four. The government hopes thereby that the state-controlled section of the banking sector, which has long been under pressure due to stressed balance sheets, will find itself strengthened if these banks pool their resources. Combined with the front-loaded recapitalisation of PSBs announced earlier, the government clearly hopes that larger banks will recover some of their risk appetite and step up lending to the productive sectors of the economy — which would, in turn, spark an economic revival. The plan for PSBs was, in fact, announced just a few hours before the scale of the growth slowdown was revealed by the National Statistical Office.

Certainly, the logic stated by the government does not go far enough. What is additionally problematic is that the history of merging state-run corporate entities in response to government diktat in India is not particularly encouraging, across sectors. Operational efficiency from such mergers of public-sector units is often elusive, especially if layoffs and other cost savings are minimised. In this sector, in particular, the question is one of independence, autonomy, and the credibility of the public-sector banks' boards. When the government takes a decision like this, it is harder to make the claim that the bank boards are doing their job independently. Ideally, decisions to merge should be made by bank boards, fulfilling their stated responsibilities.

It is ironic that the government, in response to criticism of PSBs and their operations, has said that it seeks to further empower the boards. Confidence about such empowerment, or even the genuineness of the government's intent to eventually empower the boards, is unlikely to survive such major changes being essentially dictated to bank boards by bureaucrats in New Delhi.

The government's objective in merging the PSBs is praiseworthy, and deeper balance sheets might well help in the short run. However, the systemic problems within the state-controlled banking sector must be addressed if any revival of credit is to be of the quality that would support sustained growth. The focus should be on real governance reforms. Road maps for such reform are widely available, including from the P J Nayak committee on banking reforms. The committee had made many important recommendations, such as legal changes to allow for reducing government stake below 50 per cent in PSBs. Even before such stake sales and the eventual dissolution of government ownership, at the very least a bank-holding company must be set up. The committee recommended that the bank-holding company should be transferred the government's shares in the PSBs and, thus, it could serve as an institutional firewall between the government and the bank managements. This recommendation has, however, been put on the back burner. The Banks Board Bureau, set up as an interim step, was soon seen to be ineffective. In the absence of moves towards genuine reforms in a large section of the Indian banking sector controlled by the government, all other measures will be seen as cosmetic. And an inefficient banking system would continue to impede an efficient allocation of capital.