Union Budget 2021 may focus on governance reforms for banks

When the Narendra Modi government came to power in 2014 with the promise of reforms, steps were initiated to step up governance reforms in public sector banks. A Banks Board Bureau (BBB) was set up to select chief executives and the post of chairman and managing directors of public sector banks was split. Later, merger of public sector banks was started – State Bank of India’s associate banks were merged and then 13 banks were merged into 5 – in two phases.

While initial steps were taken to foster reforms in public sector banks, the process was not followed up with greater speed. One of the key recommendations of the PJ Nayak committee – which was set up to review governance reforms of banks in 2014 – was that the government should distance itself from the appointment of chief executive and board members of public sector banks. However, the government continues to make the appointments, and the BBB is entrusted with only selecting the candidates.

The PJ Nayak committee also recommended the government needs to reduce its stake in the public sector banks, but that has not happened either. The government continues to be the majority shareholder in public sector banks. Only in the case of IDBI Bank, the government reduced its stake below 51%, by selling the shareholding to Life Insurance Corporation of India (LIC) – an entity wholly-owned and controlled by the government.

“There is a very large gap between the good practices in corporate governance that was recommended by the PJ Nayak Committee report and what has been implemented so far,” said Ashvin Parekh, managing director, Ashvin Parekh Advisory Services.

“We may find in the budget, a framework rather than specific recommendations or we may find the constitution of an organisation to look after public sector banks’ governance issues.”

“Since BBB did not get the kind of empowerment that was essential, so perhaps they may constitute something under the ministry. And they will make sure that the particular group comes out with proper framework and guidelines,” Parekh said.

He also said the governance issues that the budget could address may not be only for public sector banks but also can cover private sector banks. “Between 2017 and 2020 – a number of large private banks also had governance issues. We may find that there are some guidelines on private sector banks’ governance issues as well,” he said.

The speed at which public sector banks are losing market share to private banks has been intensified in the last five years. Between 2015 and 2020, public sector banks’ market share plunged from 74.28% to 59.8%. Their deposit market share dropped from 76.26% to 64.75% during the same period.

Bad Bank / DFI

Finance ministry officials in the recent interactions with the media indicated that the idea of setting up a bad bank are still being discussed. A bad bank is one which buys toxic assets from other commercial banks at a price decided by the bad bank.

Bad loans in the Indian banking sector have been coming down after peaking in March 2018. According to the Reserve Bank of India data, from a peak of 11.5% in March 2018, gross non-performing assets of scheduled commercial banks has fallen to 7.5% in September of 2020. However, due to the economic stress due to the Covid-19 pandemic, an avalanche of bad loans is expected to hit the banking sector. The central bank has estimated gross NPAs to hit 13.5% in September 2021 under the base case scenario and to 14.8% under a severe stressed scenario.

“The government is tossed up between the bad bank and the development finance institution. I am getting a sense that for the purpose of infrastructure funding and large corporate borrowing – on the asset side and not on the working capital side – for the purpose of long-term capacity building, there may be some allocation there. So, the announcement of a development finance institution may take place,” Parekh said.

Capital infusion

The government may also have to allocate capital for public sector banks because bad loans may rise, for which banks need to make additional provision. Apart from regulatory capital, these banks will also need growth capital to support the economic recovery in the next financial year. Public sector banks overwhelmingly depend on government for capital as they are unable to raise funds from the markets due to subdued valuations.

“There will certainly be some indication on the amount of recapitalisation. They have to allocate a certain amount. I am not expecting a big amount because the government has already spent a lot on stimulus programmes,” Parekh said.

“However, the finance minister has to recognise that the entire stimulus has been at the cost of the banking system. Whether it was stimulus packages - ECLGS I or II [Emergency Credit Line Guarantee Scheme] or Covid-19-RBI – these are all on the assumptions that there will be borrowers who will be allowed to borrow from the banking system, so the banking system needs more capital. There is also an expectation that there could be a larger amount– somewhere around Rs 70,000 crore to Rs 80,000 crore for recapitalisation of the public sector banks,” he said.

(The writer is a Mumbai-based senior journalist)