As Union Budget 2021-22 draws closer, the focus on India’s large state-owned banking sector has returned.
Since 2015-16, the government has had commit over Rs 3.22 trillion in cash and bonds to recapitalise public sector banks. To reduce this drain on resources, the Narendra Modi-led government has toyed with ideas ranging from consolidation to privatisation and the setting up of a Bank Investment Company. The proposal of a bad bank also makes frequent reappearances as bad loans, and the prospect of them worsening, hamper the flow of credit to the economy.
One unfinished agenda that the government could address in the coming Budget is to set up a bank holding company which will solve multiple problems at one go, said A Prasanna, head of research at ICICI Securities PD. “If executed in the right manner, the move can lead to governance reforms and will improve the valuation of banks which will help the government to divest its stakes,” said Prasanna, adding that the government will not have to repeatedly infuse capital into the banks every year. “The holding company will also take us closer towards ownership-neutral regulations. It can become a tool to solve a lot of problems,” he said.
The Holding Company
The idea of a ‘Bank Investment Company’ idea was first mooted by the PJ Nayak Committee in 2014 to review the governance of banks in India. The current Chief Economic Adviser Krishnamurthy Subramanian was a member of that committee.
However, in discussions pertaining to the holding company in past years, the government has sought to retain powers of appointment of top management of PSU banks – the managing director, chief executive officer and executive directors. This would have created another layer of DFS, said a former official from the Department of Financial Services, speaking on condition of anonymity.
While the government has dithered on the idea of a holding company, it has moved to consolidate the number of public sector banks. Further consolidation may remain on the agenda.
A former finance ministry secretary, speaking on condition of anonymity, said that the government had intended for a total of eight state-owned banks when it was drawing up plans for mega mergers in 2019. At present, there are 12 such lenders.
In September 2019, the government announced mergers of ten state-owned banks into four. At that time, one more consolidation had been planned but not announced, said a second former secretary in the finance ministry.
The last of these planned mergers was put on hold due to concerns raised by the Reserve Bank of India on the financial parameters of the lenders proposed for consolidation, the second official said. Bank of India and Central Bank of India were thought to be the potential anchor banks, the first official quoted above said.
Among the remaining public sector lenders, Indian Overseas Bank was considered too weak to be merged. Punjab and Sind Bank mostly dealt with agricultural business and the idea was to convert it into a regional rural bank. Due to political compulsions, the government had decided to not merge Bank of Maharashtra, the first official cited above said.
Meanwhile, views on privatisation of government-owned lenders are yet to evolve.
A new public sector enterprises policy is being worked on, under which the government will draw up a list of strategic sectors—each with a maximum of four state-owned companies. According to a senior official in the department of financial services, this policy will address the issue of state-owned banks separately.
When it comes to divestment, two major factors are valuation and usefulness of the exercise, said a third former secretary in the finance ministry, who was privy to previous discussions on bank privatisation. The person spoke on condition of anonymity. Another secretary-level official pointed out that state-owned banks have a large network of branches in remote areas of India and spearhead government schemes. Privatisation is a social equity issue more than anything else, the official said.
So far the government has only divested stake in IDBI Bank Ltd, which was set up under a separate act of parliament. As such, the transfer of equity from the government to Life Insurance Corporation of India in 2019 did not require an amendment to the Banking Regulation Act.
Alongside potential structural changes, the government has discussed the idea of setting up a ‘bad bank’ in detail with the Indian Banks’ Association recently, even though it is still not willing to become a promoter of such an entity. As such, other options such as an Asset Reconstruction Company model, collectively owned by lenders, have been discussed, BloombergQuint reported last week.
A ‘bad bank’ essentially helps banks clean up their balance sheets by transferring the bad loans to an entity structured as an asset management company or an asset reconstruction company. This could potentially help improve credit flow to the economy. The idea, which has been discussed and shelved many times over the past few years, is back on the agenda as bad loans could rise once again from already elevated levels.
Development Finance Institution
The other idea that may find prominence in the upcoming budget is that of setting up a development finance institution to help fund India’s infrastructure plans.
Infrastructure projects typically have a long gestation period of 15-20 years and banks hesitate to fund such projects due to asset-liability mismatch. This is particularly true after the previous infrastructure lending boom in the 2010-12 period left lenders saddled with bad debt.
In a scenario when most banks have reached their sector exposure limits and private banks do not want finance large projects, DFI assumes importance, said the first official quoted above.
One option is to convert India Infrastructure Finance Company Ltd. into a DFI, for which a Cabinet note was prepared, according to a finance ministry official. IIFCL is a government-owned entity, which is registered as a non-deposit taking NBFC with the Reserve Bank of India. The firm, set up in 2006, is the only state-owned financial institution that lends to all the infrastructure sub-sectors.
The government, however, may also consider setting up a new development finance institution with a capital base of Rs 1 lakh crore, Vinayak Chatterjee, chairman of Feedback Infrastructure, told BloombergQuint earlier this month.