The Narasimham Committee on Banking Reforms, in its second report, has combined drastic surgery with a strong dose of medicine to cure the ailing industry.
IN the post-reform era, India's financial sector is in a state of evolution and this necessitates many policy corrections. The banking sector, which handles 80 per cent of the flow of funds in the economy, had its first dose of reform in 1992 when prudential accounting practices were introduced. Six years on, the Narasimham Committee on Banking Reforms, set up by the Finance Ministry, has submitted its second report.
The committee's second reform package is based on a review of the performance of the banking sector since 1992 and also trends in the international banking industry. Meanwhile, the Khan Committee, assigned by the Reserve Bank of India (RBI) to analyse the role of Development Finance Institutions (DFI), also submitted its report.
The Narasimham Committee has made a radical recommendations to dilute government equity in nationalised banks to 33 per cent. It has also suggested that the RBI nominees on bank boards step down. The rationale behind this suggestion appears to be that real autonomy is inconsistent with public ownership, although an earlier panel, the Committee on Financial Supervision (CFS), had held that productive efficiency and profitability were ownership-neutral as long as banks were given the freedom to function within a well-defined framework of regulation and prudential norms.
Is functional autonomy really inconsistent with public ownership? Most chairmen of nationalised banks seem to think so. They say that it is not so much directed credit that has eroded their viability (after all, even private banks are subject to the same lending quotas but are still profitable); it is the lack of operational autonomy as well as interference in their day-to-day functioning that are at the root of their poor performance.
The lack of autonomy is reflected in the fact that there is a common wage package for all bank employees irrespective of the health of the bank concerned. Kannan, the Chief Executive Officer of Bank of Baroda, said: "Give us the freedom to fix our own wages and offer market remuneration to professionals. Do not tie us down to a common wage structure. Let each bank decide its appropriate level of wages."
Vigilance is another bugbear of bankers. They say that government officials, who are clueless about banking economics, are posted as vigilance officials and there is the threat of a vigilance inquiry each time a bona fide lending decision results in a bad account. Bankers say that they are flush with funds, but credit is not taking off because of fear psychosis. A top banker said: "You become averse to risks in such an environment. Many of us are turning to narrow banking and stick to gilts."
Another problem area that the Narasimham report has commented on is behest-lending. Bank boards are staffed with government nominees (often Members of Parliament or Legislative Assemblies or other politicians) who, bankers allege, interfere in their day-to-day functioning apart from seeking to have a say in the policy decisions of the board.
The logic of linking performance to public ownership appears flawed. Even within the framework of public ownership with its attendant lack of autonomy, not all the nationalised banks have performed badly.
How do some banks perform better than others even though they have the same lending targets for the priority sector, apply the same provisioning norms, have government or RBI or political nominees on their boards and follow the same wage structure? Does the problem lie elsewhere? For instance, in the reluctance of the bank leadership to defy political pressure and take independent commercial decisions? Or in faulty management practices and poor risk evaluation? Or in the proliferation of unremunerative branches owing to lack of proper planning?
Even if it is conceded that lack of autonomy is a major issue, does the answer lie in diluting government ownership? Will that not be tantamount to throwing the baby out with the bathwater? The conditions that existed when Prime Minister Indira Gandhi nationalised 14 banks in 1969 have not ceased to exist. In the post-nationalisation period, the network of branches expanded considerably, even in remote areas, and this contributed in no small measure to the development of backward and far-flung areas. Without priority sector lending targets, could the country have made the strides it has in agriculture and the small-scale sector? Directed credit was a policy dictated by needs that are still relevant.
Dilution of government stake in nationalised banks will eventually result in the control of these banks by private enterprise, as was the case in the pre-nationalisation era. Being a capital-intensive industry, banking is bound to be dominated by a handful of big industrialists. Would such ownership patterns in a critical industry such as banking be consistent with the nation's social and development objectives?
Apart from being undesirable, the recommendation is unrealistic. Even though the Government has allowed profit-making banks to dilute government stake to 51 per cent, why is it that none of the nationalised banks has done so? Government equity is between 66 and 68 per cent in most banks because of a host of factors including employee resistance. In this context, how realistic is it to expect banks to reduce the equity to 33 per cent if the Narasimham Committee's recommendations are accepted?
It is critical to examine the feasibility of giving functional autonomy to banks within the framework of majority government stake. Can the Government not professionalise the bank boards and allow them the flexibility to take commercial decisions while still retaining its stake? The panel appears to have ignored this option in favour of dilution, although it does say that bank appointments should be de-politicised.
For the Narasimham Committee, big is beautiful. Therefore it has recommended that the establishment of three large banks with international structure, eight to ten national banks and a large number of regional and local banks. This, the committee has suggested, can be done through mergers. Bankers agree that size is a critical criterion for international operations, but disagree that the merger route is appropriate for building strength.
Kannan said: "What is the use of mergers if you have the same loan portfolio, same capital adequacy, same provisioning requirements and possibly an overlap of branches? Mergers will have to result in greater efficiency and rationalisation of branch network and operations. Otherwise they will not be profitable." Bankers also believe that mergers cannot be ordered by fiat; they have to be driven by business considerations. This is a point conceded by the report. Top bankers favour the equity route to expansion rather than the merger route. They say that although the State Bank of India took over many banks, it did not opt for mergers.
Non-performing assets (NPAs) have been the bane of the industry. The panel has identified poor credit decisions by managements, cyclical changes in the economic environment, directed credit and crude forms of behest-lending as the factors responsible for poor asset quality. The panel points a finger at priority sector credit as having a high contamination coefficient and suggests that quantitative targets have caused erosion of asset quality. It laments the fact that infusion of recapitalisation funds notwithstanding, NPAs remain uncomfortably high. Yet it recommends that advances covered by government guarantees that have turned sticky should also be reckoned as net NPAs.
The Narasimham Committee's solution for NPAs is the creation of an Asset Reconstruction Fund (ARF), which will take over the bad debts of banks from their balance sheets to enable them to start on a clean slate. Recapitalisation through budgetary infusion, the panel correctly points out, is not a sustainable option. But bankers are sceptical about the workability of the ARF. A senior banker asked, "At what price will the ARF take over my NPAs? How will the discount be worked out?" He said that the ARF cannot bail out banks under the present legal system. Although every bad debt is secured, banks cannot encash the security because of legal hurdles. The Urban Land Ceiling Act is a major deterrent to debt recovery. Bankers say that the legal system has to be revamped to facilitate recovery so that the ARF can pick up "NPAs at a viable price".
The committee has recommended that net NPAs be brought down to less than 5 per cent by the year 2000 and 3 per cent by the year 2002. "Easier said than done," says a top banker. "Already we do a lot of window-dressing. Outstanding accounts are shown as priority lending to meet targets. We keep lending to defaulters to roll over the NPAs. Fixing unrealistic targets will be counterproductive."
The committee has recommended that banks should not lend to defaulters, but bankers say that this is unrealistic. They claim that in the absence of fresh loans, the defaulting companies will close down, leading to loss of jobs. "Will that be acceptable?" asks a banker. Bankers also complain that they are forced by the Board for Industrial and Financial Reconstruction (BIFR) to lend to sick companies, yet more often than not there is no turnaround and the accounts turn bad.
The committee has recommended increasing capital adequacy and tightening provisioning norms. It targets 9 per cent capital adequacy by the year 2000 and 10 per cent by the year 2002. Accrual of interest for income recognition should be done in 90 days instead of 180 days. Even in the case of standard assets, a 1 per cent provision is recommended. "Barings Bank had excellent capital adequacy. Yet it crashed because of abnormal exposure in one case. Prudence in risk-evaluation is important," says a banker.
The committee has also recommended revision of risk-weightages. Another important recommendation is that the RBI withdraw from the 91-day treasury bills market and that interbank call money and term money markets be restricted to banks and primary dealers.
The committee suggests that foreign banks seeking to set up business in India should have a minimum start-up capital of $25 million as against the current requirement of $10 million. It says that foreign banks can be allowed to set up subsidiaries and joint ventures that should be treated on a par with private banks.
On labour policy, the panel recommends a review of recruitment procedures and training and remuneration policies of public sector banks.
An important recommendation relates to the separation of the regulatory and supervisory functions of the RBI, one that is unlikely to find favour with the apex bank which has effectively scuttled the functioning of the Board for Financial Supervision that was set up for the same purpose earlier. Bankers point out that mere separation of the two functions would be meaningless unless the quality of supervision is improved.
Experts believe that the panel has combined drastic surgery with a strong dose of medicine to cure the ailing banking industry whereas just the latter would have sufficed.
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