CNBC-TV18 in an attempt to re-imagine the future of PSU banks spoke to Montek Ahluwalia, Former Finance Secretary and Economist, and S Narayan, Former Finance Secretary and Banker.
In the summer of 1969 overnight, on the whim of a Prime Minister, without debate in the press or discussion in Parliament, 14 private banks were privatized. The feat was repeated in 1980 with 6 more banks being nationalised.
Today public sector banks with total assets of over Rs 70 lakh crore, stand at the cross roads.
As citizens we need to reimagine their future but this time it must be done with abundant debate across the nation, involving the best minds in the country.
CNBC TV18 has taken up the responsibility to conduct these discussions on catalysing public sector banks’ future and calling it PSB 2.0.
To carry the discussion forward, CNBC-TV18 spoke to the man who joined government a decade after nationalization and has seen three decades of the fall of public sector banks -- Montek Ahluwalia, Former Finance Secretary and Economist and S Narayan, Former Finance Secretary and Banker.
Below is the verbatim transcript of the discussion.
Q: The banking system has close to say 10 percent NPAs but public sector bank NPAs stand at nearly 15 percent. There are frauds in all banks but the biggest one has hit public sector banks. So, is it time to pin the blame on the ownership, is it time to ask whether the fault lies with the public sector character of these banks?
Ahluwalia: The first thing we should question is, why is it that we are having so much larger accumulation of NPAs and also these fraud cases. There are weaknesses there. So, even within the framework of public sector ownership it should be possible to have much better governance of public sector banks and better regulation and better enforcement so that these things do not happen over and over again.
We also need to ask the question that do we need to have such a dominantly public sector banking system especially when private sector banking system we have got, seems to have been doing better. For example, we probably have the largest size of public sector within our banking system - something like 70 percent or so. Other countries do not have zero public sector presence but they have a smaller public sector presence and more private sector. So, we really need to look at what are the deficiencies in governance in the public sector banks, how far are they related to public sector ownership, how far are they related to just poor regulation? The poor regulation is also related to public sector ownership.
The Reserve Bank of India (RBI) is probably in a much better position to regulate private sector banks than it is to regulate public sector banks. For ensample, if the RBI finds something fundamentally wrong in the management of a private sector banks, it can change the CEO. You can't do that with a public sector bank.
So, there a whole slew of things that we have to look at and that will require some rethinking on what upto now has been a very mechanical approach that we don't want to change our position on public sector banks and this has been taken by a sequence of governments, this is not just now.
The issue of bringing in a different approach has been there now for the last 15 years but we have somehow not been able to move forward.
Q: That is why I am asking you, is it time to privatise at least some of the PSU banks?
Ahluwalia: That is a narrower question, there are other issues which are also important but I certainly feel we need to clarify what you mean by privatise. The important thing in the public sector banks is to take government ownership below 50 percent.
The critical thing is, if the government owns 50 percent or more then the bank is subject to all kinds of rules and restrictions by virtue of government ownership.
The government could go down to 30 percent, it could still effectively control the bank but it would be the bank managers who would be freed from a lot of procedures regarding recruitment etc. So, that is one class of things.
Second issue is, should the government duplicate the work of the RBI? This has been there in the literature for some time. The public sector banks are actually regulated both by the RBI and by the ministry of finance. In my view and I have had this for some time, I don't think that finance ministry control over the public sector banks is adding any value at all. This has been recommended by expert committees. The Narasimham Committee way back in 1997 had said that, we should take government ownership below 30 percent and government can appoint nominees on the board but they don't have to be government officers.
So, the department of financial supervision, what used to be called as banking division can even be abolished.
Q: The PJ Nayak Committee recommended that PSU banks should be removed the Banking Companies Act and moved to under the Companies Act, is that what you are suggesting?
Ahluwalia: If you want to reduce the governments share in equity below 51 percent, you will have to do that. At present they cannot be done unless these Acts are changed.
The real issue is, you want to bring government equity below 51 percent and to do that you will have to change these Acts.
Q: Do you see political opposition to this? Even the NDA has been able to push its agenda - Jan Dhan or DBT or farm loans, all through the PSU banks. Therefore they also seem to want or at least whenever we ask the Finance Minister, he says there is political opposition or the political environment is not conducive for privatising public sector banks.
Ahluwalia: The Finance Minister is right that there will be a huge amount of political opposition across the board. In fact the only minister who said that he would like to go below 51 percent was Yashwant Sinha in the Vajpayee government because this was a recommendation that had been made by the second Narasimham Committee. That committee report was submitted just before the first NDA government came in and Yashwant Sinha said, I would like to do it. However within his own party he did not get support. So, he couldn't do it.
I am sure that across the board politically this is not yet popular. The Jan Dhan and these other kind of programmes, I don't think you need 51 percent in order to do that. If the government effectively has let us say 35 percent, it will effectively control the board and these are strategic decisions which through the board the government could get the banks to do. However what you don't want is micro-management and large numbers of government officials who kind of go on the board of the banks.
The present position is totally absurd because every public sector bank has a representative on the board from the RBI and a representative on the board from the finance ministry. If you say there is a governance failure in the public sector bank, then essentially these two board members become part of the failure. It is quite clear that their presence on the board is not making any difference at all.
We don't have to do this for the entire public sector. For example if some banks like say the State Bank of India is doing a good job, it is a big huge bank, you don't want to take that up - fine, let's choose some middle banks, some smaller banks and experiment.
My guess is that if government were willing to go below 51 percent the State Bank of India would love to go below 51 percent for the government because it would hugely increase its own perceptions of flexibility in the market.
I don't think that these big issues like rural lending, lending to agriculture, having Jan Dhan Yojna etc, none of this would be affected by the government going below 51 percent.
Q: There is an unspoken strategy to just shrink the PSU banks by denying them capital, so that by default India becomes dominated by private banks. You think that's a strategy?
Ahluwalia: Nobody has said that that is the strategy. That is a conclusion that you are drawing. What I am saying is, that rather than pouring huge amounts of money to recapitalise the banks, we should decide what we can afford to do. We should not follow the principle which earlier used to be done, that every bank must have capital that will allow it to expand credit by amount X.
The really weak banks, they should be put under prompt corrective action framework and they should be told to clean up the work, reduce costs, cut down branches all of that kind of stuff.
Whatever money we have for recapitalisation should go to the better public sector banks. By going to the better public sector banks, those banks will be able to raise funds from the market keeping the government equity not below 51 percent. Separately I really do feel we need to think, why can't we bring it down to 30 percent? That will require a change in law and probably won't happen before the elections but let us at least have a debate on it.
Q: What you are saying is that tweaking within this Banking Companies Act is not the way to go, the law needs to change, right?
Ahluwalia: I am saying exactly that. To say that we will dilute but only up to 51 percent is not good enough. It will not remove very many constraints.
One of the constraints it won't remove is constraints on recruitment. If you are a government organisation, you have issues of fairness and how you handle HR and how you promote people, issues of seniority etc, issues of pay and so on. I don't think you can run a modern banking system as if it was a government department and we better recognise that. The sooner we recognise it the better.
Q: Therefore looking back, would you say that nationalisation of private banks was a cardinal sin - a blunder?
Ahluwalia: Nationalisation happened in 1969, so I would say that at that time whatever the political compulsions for doing it, I wasn't in government but I have been in government for quite a long time and in 1991 Mr Narasimham gave us his first report. That report did not say that you should go below 51 percent. However there was a dissenting note in that report which was done by Manu Shroff and Mrinal Datta-Chaudhuri and they said that even if you don't go below 51 percent, abolish the banking division because this dual regulation is a bad idea. However we did not do that and that is like 27 years ago.
In 1997 Narasimham said let us go below 50 percent to 30 percent and a couple of years later Yashwant Sinha said he wanted to do it. I personally think let us get that done. That was the right thing to do.
If we do it now we are maybe 20 years late but certainly better. No point going back to 1969. The big mistake if you want a mistake, is the most recent one. The most recent one is that no political party is willing to consider going below 51 percent.
One problem that people have for example is caste based reservation in public sector banks.
Q: Is it politically unfeasible to privatise banks?
Ahluwalia: I am not competent to judge what constitutes a politically feasible thing but no one politically at the moment is for it. Yashwant Sinha in Parliament said he wanted to do it, so there was one political voice. Maybe if somebody joined issue on this seriously, you might get a few more. In these matters things can change over time.
I was talking about caste based reservation, I know that in the staff of the public sector banks, there would be a concern and a legitimate one. However if you drop below 51 percent will the caste based reservations go? I think government can make a clear direction that we are going below 51 percent but caste based reservations will not go. I would say it is worth doing that in order to get rid of opposition which is not about banking but about other aspects of inclusiveness.
Q: Montek Ahluwalia was saying you cannot tweak under the current Banking Companies Act and the banks will probably be have to be brought under Companies Act and bring down government stake. There is no hope of reform within the current legal dispensation. Do you agree?
Narayan: That is absolutely true because the Banking Regulation Act, 1969 and finally 1971 was enacted under very different circumstances and the new Companies Act, particularly 2013 is also under different circumstances.
However, if one were to look back at 1969 and look at situation under which banks were nationalized. The purpose and the objectives of that Act was to reach banks to the rural areas, to increase credit availability to the poor.
Somewhere after 1984-85, the banks changed their policy of lending to corporates into project financing. While in the intervening years project financing was handled by IDBI, ICICI, IFCI and for some reason after 1991 reforms, these development finance institutions were allowed to decay and this role was taken on by the PSU banks. As a result, two things happened. They became project financiers and the original intention of lending to the poor was given up.
Today, the poor represent a very small portion of the debt of the PSU banks.
Therefore, there has been some distortion in the development of policy towards PSU banks over the years. So, while we are addressing whether PSU banks should be privatized or not, there is also an opportunity to look back and say can this distortion be corrected. Can the PSU banks go back to their original role of actually reaching out to the needy people?
Q: Are you saying there is no need to change the law, bring down government stake and just give them a different goal -- that of rural lending?
Narayan: I am saying the goals have been unnecessarily distorted because the development financing institution were allowed to wither away. These banks today do not have the capability of making project lending, which is the reason why there are NPAs and they are doing things which they are not geared to do.
Let us not forget the Parliament still consists of people from the rural areas and who are looking at the banks from the rural point of view and not necessarily from the large borrowers’ point of view.
Therefore, it would be easily possible as a policy to first go back to 1969, 1971 requirements and say this is what the banks were meant to do and go back to it.
Today if you look at ICICI Bank, it does not get into substantial project based lending and does substantial retail lending. So why cannot our PSU banks go into that.
Q: Will you be happy if you just have mandate from the government saying no more lending to project finance only lend to rural areas? Will it really solve the problem?
Narayan: I am not saying that. Policy evolution does not come from single government order on one sheet of paper. It has to have full support of the Parliament, full support of government and in fact, it has to have full support of the banking system. All of this has moved away from the original policy and therefore the privatization can come as a second step, as it came in the case of ICICI Bank, it became a private bank – long ago it was also part of the government.
So, allow the privatization to evolve rather than to confront the politicians saying go below 51 percent, go below 40 percent. Evolution of policy towards removing distortion is important.
Q: What do you see as process then? Do you not change the Banking Companies Act at all and keep legislative structure as it is?
Narayan: Today, the Banking Regulation Act is constrained by the New Companies Act. It is important to make changes in the Banking Regulation Act, which would free itself from some of burdens which the Companies Act places on it. The changes in the Act are necessary, to enable these changes in direction as well as future changes in reduction in equity.
I am not running away from changing the Act, but I am saying the purpose of that change should be very strategic and say in two years I will be here, in five years I will be there, rather than saying I am going down to 51 percent, going down to 40 percent that alone would not pass parliament.
Q: When you say in two years I will be here, in 5 years I will be there – what kind of goals are you setting for the PSU banks?
Narayan: Suppose you set a medium term goal of saying – I will handle all the privatization in 3-5 years’ time and then you work back saying in order to get that through Parliament, Act change is necessary – what need I do? I need to change the direction of lending in the banks and gain the confidence of the people that the banks are serving the people and not a few corporates alone.
Therefore, I need to perhaps go back to revisit and say State Bank will be the main development finance institution and other banks will not do development financing.
Change the direction, watch the flow and meanwhile deal with the stress which is currently there. Give it time and then go for the change.
