B S :Editorial Comment | New Delhi Jan 1, 2013
Re-examine government's role as owner of banks
The problem of asset quality has become increasingly significant in the
Indian banking system. However, as was reported in this newspaper
on Tuesday, there is a striking asymmetry in the nature of the
problem across different categories of banks. Over
the past five years, while private sector banks have seen
some improvement in the ratio of their non-performing
assets (NPAs) to outstanding credit,public sector banks
as a group have seen a marked deterioration. The latter
collectively account for over 86 per cent of NPAs, while
providing about 75 per cent of credit. In response, the
Reserve Bank of India has proposed some measures,
including early recognition of problem assets and
information sharing between banks. These will be
finalised in a few weeks based on public feedback.
While such measures may help alleviate the problem,
a robust solution must recognise and respond to some
structural characteristics of government-owned banks,
which have contributed to the build-up.
An important one is the level of independence and autonomy
that a typical bank enjoys in making its credit decisions.
Anecdotal evidence suggests that various channels of influence
play a role in making credit decisions, thereby diluting the
effectiveness of the credit appraisal process. Occasional
revelations, such as the loans-for-bribes case involving Money
Matters Financial Services and Punjab National Bank a few
years ago, might be merely the tip of the iceberg.
These tendencies are reinforced by the criteria for the
appointment of independent directors on the boards of
public sector banks, which are seen less as effective
governance mechanisms and more as opportunities for
extracting rents. Another issue is that of incentives.
Given the relatively short tenures of chairpersons and
executive directors, the immediate recognition flowing
from an acceleration of credit growth perhaps outweighs
the negative impact of asset quality problems, which
usually materialise during the successor's tenure.
This has contributed to the well-known succession
effect, in which a new chairperson makes provisions
for all the bad assets from the predecessor's term,
thereby cleaning the slate for his or her term, but
also making the earnings pattern volatile.
These structural factors require a much deeper
examination of the government's role as owner of banks.
Indian banking system. However, as was reported in this newspaper
on Tuesday, there is a striking asymmetry in the nature of the
problem across different categories of banks. Over
the past five years, while private sector banks have seen
some improvement in the ratio of their non-performing
assets (NPAs) to outstanding credit,public sector banks
as a group have seen a marked deterioration. The latter
collectively account for over 86 per cent of NPAs, while
providing about 75 per cent of credit. In response, the
Reserve Bank of India has proposed some measures,
including early recognition of problem assets and
information sharing between banks. These will be
finalised in a few weeks based on public feedback.
While such measures may help alleviate the problem,
a robust solution must recognise and respond to some
structural characteristics of government-owned banks,
which have contributed to the build-up.
An important one is the level of independence and autonomy
that a typical bank enjoys in making its credit decisions.
Anecdotal evidence suggests that various channels of influence
play a role in making credit decisions, thereby diluting the
effectiveness of the credit appraisal process. Occasional
revelations, such as the loans-for-bribes case involving Money
Matters Financial Services and Punjab National Bank a few
years ago, might be merely the tip of the iceberg.
These tendencies are reinforced by the criteria for the
appointment of independent directors on the boards of
public sector banks, which are seen less as effective
governance mechanisms and more as opportunities for
extracting rents. Another issue is that of incentives.
Given the relatively short tenures of chairpersons and
executive directors, the immediate recognition flowing
from an acceleration of credit growth perhaps outweighs
the negative impact of asset quality problems, which
usually materialise during the successor's tenure.
This has contributed to the well-known succession
effect, in which a new chairperson makes provisions
for all the bad assets from the predecessor's term,
thereby cleaning the slate for his or her term, but
also making the earnings pattern volatile.
These structural factors require a much deeper
examination of the government's role as owner of banks.
The philosophical dimension of this issue relates to
the fulfilment of the social mandate for which banks
were nationalised in 1969 and again in 1980.
Has this been fulfilled and to what extent?
Is the current situation one in which the social
mandate itself is being compromised by weak
governance and incentive mechanisms?
The fact that the government is now seeing
new private banks as agents of financial inclusion
is one indicator that it is not completely satisfied
with the performance of the banks that it owns.
The practical aspect of the issue relates to the
need to enhance the capital of banks saddled
with high NPAs. If the government wants to
preserve majority ownership, it perforce becomes
the predominant source of new capital.
the fulfilment of the social mandate for which banks
were nationalised in 1969 and again in 1980.
Has this been fulfilled and to what extent?
Is the current situation one in which the social
mandate itself is being compromised by weak
governance and incentive mechanisms?
The fact that the government is now seeing
new private banks as agents of financial inclusion
is one indicator that it is not completely satisfied
with the performance of the banks that it owns.
The practical aspect of the issue relates to the
need to enhance the capital of banks saddled
with high NPAs. If the government wants to
preserve majority ownership, it perforce becomes
the predominant source of new capital.
It clearly does not have the fiscal space to do this,
now or in the next couple of years.
now or in the next couple of years.
How is it going to reconcile the need for control
with the imperative of more capital?
with the imperative of more capital?
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