A new wave of reforms set to sweep banking, boost capital and growth

At this juncture, allowing higher foreign stake in PSBs is the right call. It will help them increase capital and scale up business

When it rains, it pours. Typically, this means when one bad thing happens, multiple bad things follow in quick succession – making a difficult situation worse. In the context of the Indian banking space, it is the opposite: Too many good things are happening. The sector is embracing reforms on multiple fronts. 

The industry has been constantly in the news in the past decade. First, there was a massive clean-up drive by the Reserve Bank of India (RBI) through a unique tool called asset quality review. The regulator unearthed the hidden pile of bad assets and ensured that banks set money aside to address them and make their balance sheets healthy. At least three banks had 25 per cent or more gross non-performing assets (NPAs) in different quarters of the 2018-2019 financial year (FY19) and, after provisioning, four had between 10 per cent and 19 per cent net NPAs. (All figures are rounded off.) 

The banks were also forced to strengthen their credit appraisal and risk management capabilities. Yes, I am talking about public sector banks (PSBs), majority owned by the government. 

Next, as many as 11 PSBs were put under the prompt corrective action (PCA) framework, which barred them from giving fresh loans until they acquired the acumen to identify both the right sector and borrowers to lend the public money they collect in the form of deposits.

 

The next stage was consolidation. In 2017, the State Bank of India (SBI) merged five of its associate banks, along with the Bharatiya Mahila Bank, with itself. A series of mergers among PSBs followed in 2019 and 2020. As a result, the number of PSBs is down from 27 to 12.

 

Barring a few, which have not been part of the consolidation drive, most PSBs have acquired scale; they are well capitalised and have been making record profits.

 

All 12 PSBs reported profits last year. Their consolidated net profit in FY25 was Rs 1.78 trillion, representing a 26 per cent rise over the previous year. SBI’s share in this was at least 40 per cent -- Rs 70,901 crore. 

 

What a turnaround from where they were in FY18! That year, the consolidated net loss of PSBs was Rs 85,390 crore. Out of 21 PSBs then, only two had managed to post net profits – Indian Bank and Vijaya Bank (which was merged with Bank of Baroda, along with Dena Bank, in April 2019). Even SBI had posted a net loss that year.

 

All PSBs have not announced their September quarter earnings as yet. In the June quarter of the current financial year, their collective net profit was Rs 44,218 crore.

 

Besides profitability, scale and capital, there’s another critical element that forms the quartet that’s now composing the music for PSBs: Quality of assets. In the June quarter, not even one PSB had 1 per cent net NPAs. SBI’s net NPA was 47 basis points (bps); Bank of Maharashtra and Indian Bank had just 18 bps net NPAs each. One bps is a hundredth of a percentage point.

 

Against this backdrop, the government is set to launch a new phase of reforms for PSBs. As a prelude, it has already started changing the architecture of the private banking industry through subtle steps.

 

First, in October, the Appointments Committee of the Cabinet announced new guidelines for the selections of wholetime directors of PSBs. Private sector candidates now can apply for one of the four managing directors’ positions at SBI. For the remaining three, other public sector bankers can apply. So far, these positions were reserved only for internal candidates.

 

The government has also opened the doors to the private sector for the top jobs in PSBs. The selection process will involve “open” advertisement, both from private and public sector candidates. Finally, one of the four executive directors at large PSBs, which have at least Rs 10 trillion worth of business, can come for the private sector.

 

There’s more. Last month, the board of directors of Emirates NBD Bank (ENBD) and RBL Bank Ltd agreed to Emirates bank acquiring a controlling stake in RBL Bank, infusing Rs 26,850 crore into it. ENBD will pick up a 60 per cent stake in RBL Bank, merge its three branches with the Indian private bank, and eventually make it a wholly-owned subsidiary, subject to the approval of its shareholders, regulators and the government.

 

Before that, Japanese giant Sumitomo Mitsui Banking Corporation acquired a 24.22 per cent stake in Yes Bank Ltd.

 

Other recent developments include Blackstone, the world’s largest alternative asset manager, investing Rs 6,197 crore in Federal Bank Ltd to pick up a 9.99 per cent stake. And, US-based private equity firm Warburg Pincus LLC and Abu Dhabi Investment Authority (ADIA) are investing Rs 7,500 crore in IDFC First Bank Ltd. We are all waiting to see what will happen at IDBI Bank Ltd, where the government and the Life Insurance Corporation of India jointly hold 94.72 per cent, and both are planning to sell 60.72 per cent.

 

While foreign ownership in domestic private banks remains capped at 74 per cent, and the voting rights at 26 per cent, there is clearly a change in the regulator’s approach on the role of foreign investors in private banks.

 

Soon, we will see a similar development on the PSB turf. Yes, the plan is to allow foreign investors to have a higher stake in PSBs. Does this mean the government will pare its stake in these banks to below 51 per cent? Certainly not. But the foreign stake, which is capped at 20 per cent, will go up to 49 per cent. 

 

Historically, the government has been pumping capital in these banks. Until FY22, it has infused – hold your breath – Rs 4,38,780 crore to keep these banks alive and kicking. The process had started in the late 1980s. The biggest tranche was released in FY19 – Rs 1,06,000 crore, followed by Rs 90,000 crore in FY18 and Rs 70,000 crore in FY20. Without this liberal capital infusion in that round, PSBs would not have been able to clean their balance sheets.

 

The healthy and profit-making PSBs have been paying dividends to the government. In the past three years, between FY23 and FY25, they have given at least Rs 54,500 crore as dividend to the government.

 

At this juncture, allowing higher foreign stake in PSBs is the right call. This will help them increase capital and scale up business.

 

At the moment, foreign stake in PSBs is too low. It’s the highest in Canara Bank (11.88 per cent), followed by SBI (9.56 per cent), Bank of Baroda (8.71 and), and Union Bank of India (7.86 per cent). For the rest, it’s less than 5 per cent; and is just a few basis points in at least three banks.

 

What has been the government’s stake in PSBs? The floor is 51 per cent but in at least three banks, it’s more than 90 per cent. In SBI, it is 55.5 per cent. Among the rest, it varies between 62.93 per cent and 89.27 per cent.

 

Will the government sell its stake to foreign investors? No. My guess is that the PSBs will raise fresh money through qualified institutional placements and other instruments. Since they are healthy and profit making, there will be many suitors for them. 

 

One caveat, though: To make it a success, the government should take a relook at the way it handles these banks.

 

Many moons ago, former RBI governor YV Reddy pitched for a strategic, limited, and purposeful government ownership in PSBs, while emphasising the need to end the "dual control" of PSBs by both the government and the banking regulator. He had referred to the government, PSBs, and the RBI as a "Hindu undivided family", where the banks often bear the cost for government-mandated schemes. 

 

I am sure lifting the cap on foreign stake in PSBs will change things. After all, Prime Minister Narendra Modi has said that banks should be treated as business entities.

    The writer is an author and senior advisor to Jana Small Finance Bank Ltd. His latest book: Roller Coaster: An Affair with Banking. To read his previous columns, log on to www.bankerstrust.in   X: @TamalBandyo