Reform PSBs

Time is up for directed lending approach

The state of India’s public sector banks (PSBs) has improved in recent quarters. Gross non-performing assets (GNPAs), for instance, have come down from 14.6 per cent in March 2018 to 11.3 per cent in December 2019. The number of PSBs under the Reserve Bank of India’s (RBI’s) prompt corrective action has dropped to four, and 12 reported profits in the first nine months of the current financial year. The provision coverage ratio has also improved. Some of these indicators suggest that the worst may perhaps be over for PSBs as a group. However, they still have a long way to go before being able to freely lend to the productive sectors of the economy. One of the biggest problems for PSBs is the lack of a clear road map for reforms.

 
Union Finance Minister Nirmala Sitharaman unveiled the next fiscal year’s PSB reform agenda for technology-enabled banking on Wednesday. Some of the steps such as facilitating loans to retail borrowers and micro, small and medium enterprises through digital modes and the use of analytics will help both the customers and banks. But these may not go far enough to put the PSBs on the desired growth trajectory and enable them to service the credit requirement of the productive sectors of the economy. At a broader level, statements from the government show that PSBs are still heavily influenced by it. For instance, asking PSBs to push credit supply at a time when economic activity and demand are weak could lead to asset quality issues at a later stage. This also reflects the difference between the objectives of the government and lenders. The government would want to see the flow of credit increasing, which will help push up economic activity. However, banks would prefer to be more cautious in a weak economic environment. Excessive directed lending without proper due diligence in the aftermath of the global financial crisis contributed significantly to the stock of NPAs in PSBs. Instead, the need is to build better risk-assessment capabilities. This will, to a large extent, also reduce the dependence on reports from credit-rating agencies.

In fact, PSBs need wider operational and governance reforms. While some of the operating indicators are now improving, the fundamental weaknesses of PSBs became more visible in recent years. As a result, the business is rapidly moving towards the private sector. A recent RBI report on the banking sector, for example, showed that the average share of PSBs in incremental term deposits declined from 77 per cent in 2011-15 to 13 per cent in 2016-19. Similarly, incremental credit is also moving away from PSBs. Since PSBs still dominate the Indian banking system, weak balance sheets and inability to extend credit directly affect economic activity. In this context, the finance minister has done well to clarify that the proposed merger of PSBs is on track. While the merger itself may not improve things, as the previous exercise suggests, uncertainty on this front will further affect the operational performance of the banks concerned. Even though the merger looks difficult in the given time frame, the government would do well to work on governance reforms. One proposal gathering dust is a structure where each PSB would either independently have its own holding company or collectively have one that hold its shares. The government would do well to accept such a structure.