Stressed Assets in PSBs :The way ahead

The Reserve Bank of India (RBI) recently released the Annual Report, in which the then RBI Governor Raghuram Rajan mentioned about the stressed assets resolution. 

The asset quality review undertaken by the banking industry has certainly helped improve recognition of NPAs and provisioning norms. To improve management of stressed assets, two pronged strategy is being proposed — new management team if necessary, and tailoring the capital structure to the project’s situation. The need is to take an overall big picture analysis, especially of public sector banks (PSBs), covering governance, cost structure, risk management including cyber risk, technological upgradation, customer service and grievance redressal, amongst many issues, indicated by the RBI.

Earlier, the Financial Stability Report of the RBI had emphasised that economies around the world are experiencing uneven growth, poor recovery, deflationary pressures, geopolitical risks and uncertainties. In view of the spillover effects, and interconnected global economy, no country is insulated from shocks. 

Though India is the fastest growing economy in the world, banking sector, which mirrors stress in corporate sector, continues to be a matter of concern. The risks to Indian banking sector has increased recently on account of deterioration in asset quality. The stress tests on banks in 2015-16 had indicated that gross non-performing assets (GNPAs) may deteriorate further to 8.5% by March 2017 from 7.6% in March 2016 and 5.1% in September 2015. 

The RBI had observed that if macro situation deteriorates further, GNPAs could rise to 9.3% by March 2017. In keeping with the RBI’s projections, S S Mundra, Deputy Governor, RBI recently expressed concerns about PSBs, based on first quarter results ending June 2016.  

While banks are focused on repairing their balance sheets, RBI has undertaken measures to enable banks to identify asset quality, timely restructuring of viable assets and recovery of unviable assets. In this context, former Governor Raghuram Rajan, in his recent speeches had mentioned about the extraordinary exuberance in 2007 and 2008, when economic growth was strong and opportunities were limitless. In that period, banks made mistakes in extending loans, as happens often, without ensuring due diligence in evaluating proposals. He also acknowledged that there have been instances of malfeasance, which are being examined by the Central Government and the RBI. 

 The NPAs in PSBs are significantly higher than private sector banks and foreign banks. The sectors which are recording stressed advances are infrastructure, construction, engineering goods, basic metal and metal products, cement, paper and paper products, textile, food processing and mines — all of them recording stressed advances ratio of more than 16% of their respective sectors. Granularly, bank-wise, final results of many PSBs for fiscal 2015-16, were poor, and the government, being owners of PSBs, has been initiating various actions like strengthening the selection process of top management, setting up of stressed assets fund and recovery tribunal, and legislating bankruptcy code. The government has also, already, allocated sufficient funds to recapitalise the banks over next few years.

Consolidation issues

The issues related to consolidating Indian banking sector has been debated and discussed for many years, and merger has been a preferred recommendation consistently. Accordingly, in India, many banks in the past were merged with other banks and the government recently announced merger of the State Bank of India and its associates. 

Mergers can be successful in unique conditions and institutions but cannot be universally adopted because it leads to job cuts, branch closures and in some cases, lowering in quality and quantity of services. Hence, in addition to mergers, the government would need to consider other alternatives.  

One such alternative could be initiating the process of privatising some of the inefficient loss-making PSBs. Globally, many countries like Argentina, Australia, Brazil, Bulgaria, Chile, Finland, France, Indonesia, Italy, Korea, Mexico, Spain, and Sweden have privatised their nationalised banks. The method of privatisation has varied across countries. In the Soviet Union, voucher privatisation was undertaken with an objective of egalitarian distribution to individual citizens. In Finland, the method was privatisation by asset sales. Most widely used method is by offering an IPO, which serves to foster capital market development. The global evidence is that better financial performance is ensured when a strong financial institution is involved as a significant shareholder in privatisation.

Political constraints

The challenge to privatisation would be the political ideology, because it implies that the 60-year old policy of social control would need to be dismantled. In India, since 1991, PSBs have been tapping the capital market but not out rightly privatised. In 1999, after review, privatisation was considered impractical and expensive due to inability to attract private investors as well as cost of restructuring... The decision to privatise inefficient and unproductive PSBs, consistently delivering negative returns, would require wide debate and discussion, especially in the context of Jan Dhan Yojana, mobile banking and Aadhaar card seeding  — developments of last 24 months. 

But, as Finance Minister Arun Jaitley recently observed that India is yet not ready for privatisation of PSBs, another alternative, could be considering sale of bank branches of loss making PSBs to recover losses and not providing support from the Union Budget. This is similar to disinvestment which has been undertaken in the economy for more than a decade.

In India, PSBs, enjoying a gilt-edged status and nearly 70% of market share, should serve as benchmarks for the banking sector, and certainly not be a burden on national exchequer. 

Also, is it not yet time to consider whether the innocent tax payer has to bail out the PSBs, should the employees, including top management, of a loss making PSB, not share the cost too?

(The author is the RBI Chair Professor of Economics, Indian Institute of Management, Bangalore)