Untenable status quo

A new paper shows the need for urgency of PSB reforms

A sustainable recovery from the pandemic-induced economic contraction will to a large extent depend on the ability of the banking system, particularly public-sector banks (PSBs), to lend to the productive sectors of the economy. But PSBs in their current form (their gross non-performing assets are set to go above 15 per cent by the end of the current financial year) would not be able to support the economy and need reforms as the government is not in a position to continuously infuse capital. Though the issue of PSB reforms has been under discussion for several years, not much has moved on the ground. A new paper by former RBI governor Raghuram Rajan and former RBI deputy governor Viral Acharya has taken the debate forward. 

They have rightly argued that the present situation is fiscally untenable. While some of the points discussed in the paper such as giving operational independence to the boards and strengthening the incentive structure for the management are well known, it has argued in favour of winding down the Department of Financial Services as an affirmative signal to grant bank boards and management independence. In terms of ownership, the paper suggests that the government can bring down its stake below 50 per cent in some banks, which will create distance from operation and improve governance. Select PSBs can be privatised in a careful and calibrated manner.

In the area of resolving bad debt, the paper discusses the idea of a bad bank. If it is set up as a public-sector entity, investigating agencies may not question public-sector bankers for selling assets to it because the transaction would be between two public-sector entities. Public-sector bankers are often unwilling to recognise losses because of the fear of investigative agencies. However, employees of the bad bank would face similar problems as they will have to deal with private entities and write down the assets. To address pricing concerns, the paper suggests creating a more liquid market for distressed loans. But developing such a market would always be difficult in reality because PSBs may not be able to participate freely at the initial stage, which will affect volume. Also, the idea of holding assets until the demand improves in a particular sector may not work because the cost could easily outweigh potential benefit. 

While some of the suggested solutions to deal with bad assets can be debatable, the paper offers several important prescriptions to improve the performance of PSBs. The bigger question worth debating is whether the government has the willingness to avoid piecemeal reforms, which do not move the needle. The Narendra Modi government made all the right noises at the beginning of its first term, but not much has changed over the years. To be sure, the government of the day benefits from bank ownership, which can be used to support any particular sector or a segment of the population. It is often used to push up economic activity in the short run for political reasons. Things would perhaps change only when the government is convinced that the transformation of the banking sector can’t happen through incremental reforms.