Sucheta Dalal :Banking reforms: more threat than promise
Sucheta Dalal

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Banking reforms: more threat than promise  

Jan 3, 2005

PSU banks are forced to operate within the frame-work of conflicting pulls and pressures within govt

When the search committee to select the next chairman for the capital market watchdog met last week, people were surprised that M Damodaran was one of the names on the shortlist of five. The question is; why would Mr Damodaran be considered for another job when he has just taken on a fairly gigantic one of turning around IDBI? The answer probably lies in the fact that a turnaround in the nationalised banking sector is rather more difficult than working magic at India’s largest mutual fund.

Public sector bank chairmen are forced to operate within the framework of conflicting pulls and pressures from the finance ministry and RBI, and suffer their slow decisionmaking and interference—all this at salaries that are a fraction of those earned by senior executives in private banks.

Consider this. For the last five months, the government has frequently repeated its resolve to permit 74% foreign direct investment (FDI) in private banks. Yet, the RBI hasn’t budged from its draft guidelines that say—no single entity (unless it is widely held) can hold more than 10% of the equity of a private bank. Yet, the RBI itself had shown no consistency in its past clearances of FDI in private banks.

Similarly, the government’s avowed support for consolidation and merger of nationalised banks caused a flutter in the stockmarket, but has made little progress on the ground. So far, Bank of Baroda is wooing Dena Bank and Bank of India has announced an alliance with Union Bank of India. State Bank of India and IDBI have declared that they are seeking interesting partners.

These announcements caused the BSE bank index (Bankex) to shoot up 31% in six weeks from 2,660 on October 15 to 3,495 on December 9. It rose another 8% after a small lull to 3,722 on December 31. This is merely based on speculation and hope. There are far too many structural issues that need to be addressed before banks can truly turn into attractive investments.

• Govt’s resolve on FDI in banking conflicts with RBI’s draft guidelines

• Govt claims to support consolidation but is reluctant to give autonomy

• Reform in 2005 must give aim at giving more space to nationalised banks

The UTI bank imbroglio is a good case in point.

The government’s belated action to ensure the continuance of PJ Nayak as chairman and managing director was welcome. But there is still no clarity over whether government entities want to hang on to a majority stake in UTI Bank or are willing to let it go.

If they choose the latter, then an exit strategy must be decided before government holding is diluted further, in order to get the best price for UTI-I’s shareholding. Already Hongkong Bank (HSBC) and Barclays are waiting in the wings with a 15 and 5% stake respectively. A slow consolidation of their holdings will kill the prospect of competitive bidding and lead to a lower realisation for UTI-I if it chooses to sell out.

There is similar confusion about PSU bank mergers. On the one hand, the government claims to support consolidation, and has allowed all banks to be publicly listed; but it refuses to allow even basic operational autonomy to nationalised banks. The finance ministry insists on banks seeking specific approval of simple decisions such as raising fresh capital, declaration of dividends and branch expansion, inspite of having a representative on the board who acts like a super-chairman.

Banking reform in 2005 must aim at giving up this obsessive control and unshackling nationalised banks, giving them procedural autonomy and allowing them the space to be more competitive through quick decisionmaking.

Mr Damodaran, who has worked in the finance ministry, the RBI and is now a bank chairman had a clear and succinct list of reforms that are necessary to for PSU banks to be in a position to compete equally with foreign banks. It is only fair that these reforms are in place before the government exposes the banking sector to foreign competition by permitting 74% FDI and removing the cap on voting right. Mr Damodaran’s prescriptions are as follows:

o Structural issues cannot be add-ressed incrementally and the country will be better served by setting up a banking commission. The commission will discuss issues through wide consultations and adopt a more holistic approach to reform, instead of allowing banks to be buffeted between the finance ministry and RBI. This is long overdue.

o The government must make a distinction between regulation and control by formalising its intervention in the working of nationalised banks. As the majority shareholder, it does have the right to decide broad policy issues and direction, but this must be conveyed through its nominee on the board of directors rather than a series of directives issued to the chairman. The board comprises eminent people from different disciplines who bring in diverse skills and knowledge. A board discussion may refine an idea and find better ways of implementing the government’s decision rather than a unilateral directive to the chairman.

o As a corollary, decisions such as declaration of dividend, raising fresh capital, or opening new branches should not require separate approval from the finance ministry, once it is okayed by the board.

o Identifying the right people for senior management functions, which provide appropriate leadership for specific banks. Instead of mechanically appointing bank chairmen and moving them from one bank to another, there has to be an effort to marry specific skills with the growth needs of each bank. For instance, one bank may need a chairman skilled in personnel management, while another may need a banking whiz to steer operations. It is important to choose correctly, rather than to adopt a lottery approach.

Finally, the government must play a bigger role in directing the consolidation and merger of banks, in order to iron out ego hassles and culture clashes. It must also pay some attention to compensation packages in order to help banks attract the right talent at all levels of operation. Until some of these issues are addressed urgently, the opening up of the banking sector sounds more like a threat than a promise for a better future.

-- Sucheta Dalal