This article is written by Swastik Shukla.

Background

Nationalisation of banks in India took place in 1969 under the Indira Gandhi government. A total of 14 banks were nationalised. Before this event, State Bank of India and its subsidiaries were the only nationalised banks in India (nationalised in 1955 and 1960 by the Jawaharlal Nehru Government). The step was taken to ensure that banking services and welfare schemes could reach the backward, rural areas of the country, since private banks, as they are only interested in profit, wouldn’t cooperate with the government in carrying out the welfare measures, necessary for the upliftment of the rural, backward masses. Over time, the public sector banks have suffered from the same problem as rest of the public sector undertakings- gross mismanagement and under profit business conduct, the blunt of which has been suffered by the government exchequer, and in turn, the Indian taxpayers. However, public sector banks continue to be extremely significant for India’s developing economy, primarily for the purpose of funding infrastructure development projects and welfare schemes. 

The NPA Crisis

Although NPAs are by no means a problem which is new to Indian economy, the problem became a crisis approximately a decade and half ago, when the Indian economy was experiencing what might be called as its biggest economic and investment boom. However, things took a bad turn for the financial institutions in 2008, when the US Housing Bubble burst resulted in a financial crisis worldwide. This completely changed the growth projections which were anticipated by companies and experts. Things were made worse as RBI increased repo rate in order to restrain the inflation rate which was soaring high. Among major economies, India’s NPAs are second highest, with gross NPAs standing at 9.6%, surpassed by only Italy among the major economies. China, another Asian giant that has also witnessed an economic boom in past few decades, fares a lot better at 1.7 gross NPA. This also suggests that there is a thing or two that India can learn from China in this aspect.

The NPA crisis doesn’t just suggests that the working mechanism of public sector banks is problematic, it also points out some other, parallel problems that exist in our institutions. The coal mine scandal, the 2G spectrum scam, and the hundreds of land disputes only make us realize that doing business is far from comfortable in India.

Moving ahead we will discuss the most popular solution for the NPA crisis that many experts both in and outside the government agree with. That is the concept of bad bank. What the experts suggest is that a new bank should be created and made to buy all the NPAs that the other banks currently hold. This wouldn’t eliminate the NPAs immediately, but would allow the remaining banks to work more freely, and lend to businesses without worrying about the NPAs piling up on their balance sheets. In the meantime, the bad banks try to recover as much value as it can from the bad loans that it had purchased from the commercial banks. It should be noted that these bad banks don’t lend or take deposits, and understandably so.

Although the idea of forming a national asset management company (nationalised bad bank) is very much on the table, it is yet to be realised. Former RBI Governor Raghuram Rajan doesn’t approves of the idea, stating that this wouldn’t destroy the disease, but merely fix the symptoms for some time. The concern is that once the banks are bailed out in this fashion by the government, they will continue to act recklessly and lend more bad credit. This is a serious issue which suggests that even if an asset management company/bad bank is formed, we cannot expect it to do anything better than allowing the banks to lend more, which will be a temporary fix for the liquidity crunch that the market faces at the moment. 

This prompts us to explore the measures China took in order to combat its own NPA problem. The measures that China adopted to combat this problem can be summed up as follows-

1. They strengthened the nationalised banks and state-owned enterprises- The Chinese introduced reforms to improve the financial status of state-owned enterprises and reduce their debt. In India too the core sectors which the government bureaucracy controls directly need major reforms in order to improve their financial condition. The Chinese strengthened the banks by raising disclosure standards across the board, resulting in improvement of the management and administration of banks on all levels. 
2. Asset based securitization- This has been recommended by the International Monetary Fund (IMF) as well, as one of the most prudent ways of increasing liquidity and allowing banks to lends. This kind of securitization involves the banks selling their assets to a third party, say an investment firm, and receive cash in consideration. The investor firm will buy these assets and then issue securities that are similar to bonds, which will be bought by individual investors. This allows the banks to get cash quickly, and since the investor firms are privately owned, they have the incentives to work hard and sincerely to extract as much profit as possible from the asset backed securities. This also helps in a fair valuation of the assets. 
3. Allowing debt/equity swaps- This allows the banks and other corporations to escape debt easily, and it’s carefully allowed only in cases where there is a good possibility of financial growth for the said corporation.
4. Giving incentives such as tax breaks and exemption from administrative fees- These are normal incentives which can be provided, although it is difficult to do so in India, given its liberal democratic style of governance where such steps can be accused of “crony capitalism”. 

Now while some of these measures have been touched upon, they are yet to be applied in the Indian context on a similar scale, with similar commitment. The securitization part is especially important, as it allows private players to become stakeholders in the field of asset restructuring, and these guys have the incentive as well as the expertise to carry out the corporate restructuring in a manner that extracts maximum profits, for both the banks and the investors.

The management of Public Sector Banks

It has to be noted that Indian economy has only gone through one wave of structural reforms. This came in the form of 1991 New Economic Policy, presented by the then Finance Minister Dr. Manmohan Singh, while the political backing came from the then Prime Minister P.V. Narsimha Rao, who, despite the spike in GDP growth rate during his tenure, which was a direct result of the Liberalization, Privatisation and Globalisation (LPG) reforms, lost the 1996 General Elections. This perfectly sums up the dangers that any political party faces while trying to bring in radical reforms. As a result of this, most if not all reforms have been introduced in times of crisis only. The drop in GDP of the country due to the coronavirus pandemic and the subsequent lockdown measures can serve as the ‘crisis’ in the shadow of which the government can push through with the reforms in banking sector which the Indian economy desperately needs.

The potential solutions, both long term and short term, that the Government of India and RBI can come up with include the following-

1. Establish a Bank Holding Company- Given the current scenario, it is clear that the banks are in a dire need for better management, as soon as possible, and with minimum risks for both the banks and the politicians. Establishing a Holding Company that owns the stakes in the banks and simply controls the management of assets, without itself contributing to the production of any services, will help in better management of the assets and spreading out the legal liabilities among its various subsidiaries (the banks that it had subsumed) to reduce overall risk. The holding company provides immense capital and also helps in diversifying the investments of the subsidiary banks. However, the Holding Company would be successful at appointing meritorious candidates on key management positions only if it is not working under the influence of the Government, or the Department of Financial Services in the Ministry of Finance to be precise.
2. Abolish the Department of Financial Services- This was suggested by former RBI governor, Dr. Raghuram Rajan as well. It has been discussed already that excessive political control over the decision making of public sector banks leads to far greater furnishing of poor loans. Crony capitalism, political gains via social welfare schemes are obvious reasons behind failing banks and their piling NPAs. It’s true that social welfare can’t be overlooked, given it is an integral part of our Constitutional scheme, but providing banks with greater autonomy would allow both the bank directors to come to an understanding with the government, and will prevent the government from going ahead with extremely problematic schemes which don’t garner much political capital for them, don’t make a serious impact in the lives of larger masses and are detrimental for the banks as well. The Banks Board Bureau, which was formed in 2016 by the current government was supposed to appoint meritorious directors for public sector banks. However, the removal of the Department of Financial Services would allow the Bank Board Bureau to work with unprecedented autonomy and the top management posts of the banks will only be held by capable top class skilled bankers who can then, discuss the use of bank credit for funding various government projects to come to an equitable solution.
3. Providing incentives to top public sector banking professionals- One major issue that has subsisted in India, even after the LPG reforms of 1991, is the absolute sorry state of affairs in the domain of public sector employees. The salary structure and the hire and fire regulations are still as they use to be in pre-1991 socialistic times. Now the public sector regulations don’t need to be overhauled to the extent where they become identical to their private sector counterpart, but the overtly egalitarian salary structure is a problem that cannot be overlooked. The problem was also pointed out by Indian National Congress MP Shashi Tharoor, where he criticised the ridiculously low pay scale of research associates in the state of Kerala. Now this provides for the depressing scenario in Indian higher education, but the deal is same everywhere, including various law enforcement agencies, healthcare sector as well as public sector banks. Even as recent as financial year 2019-2020, the HDFC Bank paid a whooping INR 27.5 crores to its top two executives. In contrast, chairman of State Bank of India was paid a meagre amount of INR 31.2 lakh in the same timeframe, and while the sum is not low by itself, it’s certainly not even sub-par when you compare it with the global standards. The chairman of Industrial and Commercial Bank of China, Siqing Chen made a whooping USD 4.7 lakh in contrast. Keep in mind that the Industrial and Commercial Bank of China is also a state-owned entity, like the State Bank of India. Now, we obviously don’t need to pay the officials that high, unless or until the banks grow on their own, but a first step needs to be taken to pay the higher officials more, even if it means paying relatively unskilled labour much less than what the latter is getting paid at this point. There is a reason why even Ph. D holders in this nation are appearing for the jobs of clerks. When you are getting paid just as much as a research associate, with similar job security and way less day to day work, why bother with the harder job which requires more effort and skill? The salaries (as well as in-kind of benefits, if there are any) of the unskilled employees need to be decreased, while that of skilled employees needs to be increased, (only the in-case ones, the in-kind ones generally don’t serve the incentivising purpose. A person would ultimately prefer a salary which he/she can use as per own convenience). In other words, the salary structure, at the very least, needs to be reformed along the lines of private sector.

Conclusion

It can be said that the problem with Indian banking system is not much different from the problem that ails other public sector enterprises. Surely the bureaucratic red-tape, poor infrastructure and anti-business environment in India serves as a major cause for the fall of private as well as government sponsored projects, and this is something that contributes to the piling of NPAs in the private bank balance sheets as well. However, the regulatory framework that prevents rapid development and is in some cases even “anti-development” is not something that we are discussing in this particular article. Rather the topic of discussion is reforming the public sector banks which contribute exponentially more to the piling NPAs and the credit crisis that the Indian economy faces at the moment. 

Independence of the Bank Board Bureau is a must. It was established in 2016 for the specific purpose of improving the governance of public sector banks. However, it is almost impossible to do the same without independence from the politics within the Central Government. For this purpose, the Department of Financial Services should be abolished, and the bureaucrats who are currently serving there should be appointed somewhere else to do more productive work. The holding company would be an expansion of the same bureau. It will appoint the key technocrats on important management positions, and will also own the majority stakes in the public sector banks, which will then serve as its subsidiary. This way the banks can be managed more efficiently without privatization. 

The egalitarian salary structure needs to be overhauled under any circumstances. It curbs innovation and any incentive to work hard. To make things better, more flexible hire and fire rules can be introduced, although later as bringing in such radical reforms simultaneously is impractical. Regardless, it is completely illogical for the top executives to earn hundreds of times lesser than their Chinese or American counterparts, yet expecting them to tackle the problems in the highly chaotic financial sector. This is, of course, beside the fact that the people who are employed on the top management posts are not highly trained professionals who are generally employed by private banks, and it’s only natural, given more meritorious people would go to the employer who pays them more.

The question of improving the performance of public sector banks hence comes down to bringing reforms which will hurt in the short run, might even prove to be politically harmful, but are required for ensuring long-term growth and a sustainable business-friendly environment. Some other issues also need to be solved, such as reducing bureaucratic red-tape and increasing the number of technocratic administrators to handle disputes. But these are collateral issues.

In order for banks to work well, every effort should be to reduce government control on the banks, without jeopardizing the larger public interest. As such under any circumstance, banks shouldn’t be allowed to fall in the hands of corporate houses who have a conflict of interest in the field of finance and credit. Independence from government control would also mean that the banks would refrain from lending to bigger corporate houses recklessly. This is important given majority of NPAs have resulted from loans borrowed by big corporations. As such, a stable framework has to be put in place to ensure that the culture of reckless ending comes to and end, merit is rewarded and banks cease to be a tool for achieving political goals.

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