Finance minister Arun Jaitley has finally appreciated the need for capital infusion in India’s public sector banks. Saddled with bad assets, these banks need capital, and they have started losing their market share. This was the theme of my last column. Quite a few US-based investors who have exposure to this set of banks suspect a design by the Indian government to prop up private banks. They feel the centre wants to marginalize the state-owned banking system and encourage private banks to play a larger role in the economy. Otherwise, it is difficult to fathom why the centre does not have a concrete plan on recapitalization of public banks, they argue.
In the 2016 budget, Jaitley proposed to infuse Rs.7,940 crore into these banks. This is too small an amount as public banks need at least Rs.2.4 trillion equity infusion by 2018 to conform to Basel III norms, Jaitley said last year. The government allocated Rs.11,200 crore last year after infusing Rs.58,600 crore between 2011 and 2014. Jaitley has made it clear that only efficient and better-managed public sector banks will get capital from the government. That’s fine, but what is the government’s plan for the less efficient and not-so-well-managed banks? Will they be allowed to be taken over by private banks? If not, will they get merged with other public banks? Nobody seems to know the answer at this point.
In his budget speech in 2014, Jaitley recognized the fact that public banks would need to raise money to augment capital. He said that while preserving public ownership, these banks would raise money through the sale of shares, largely to retail investors. Under norms, the government stake in these banks cannot come down below 51%. The February 2015 Budget has allowed these banks to bring down the government stake to 52% but most investors don’t see much value in public banks and this perception will not change unless these banks change the way they operate.
Janmejaya Sinha, chairman, Asia Pacific, The Boston Consulting Group, says the transatlantic financial crisis of 2008 was the creation of large privately-managed banks: they brought down the world with all the freedom they enjoyed. When they failed, the government in different nations pumped in money and, in essence, nationalized them. Sinha is in favour of a nationwide debate on the state of affairs at public sector banks and how to improve them. They need capital for three reasons: to set aside money for bad assets, meet Basel III norms and expand their balance sheets by giving loans. They also need autonomy in terms of governance as well as human resources, he points out.
B. Sambamurthy, former chairman of a public sector bank, finds fault in the business model of some of the small and medium public banks. Instead of focusing on big-ticket loans, they should get into retail lending, he says. For instance, 12% of the credit portfolio of Bank of Maharashtra consists of retail loans and 57% medium and large corporate loans. For Andhra Bank, the comparable figures are 16.5% and 50%; Dena Bank 13% and 34%; and Vijaya Bank 21% and 48%. The credit portfolios of small and medium public banks resemble those of development finance institutions more than retail commercial banks even though they are not designed to transform small-denomination retail deposits to big-ticket corporate loans. Typically, they hang on to the coat-tails of big lenders and participate in complex and large infrastructure loans for which they do not have any risk appetite.
Sambamurthy also emphasizes the need to build analytics, which is key to customer acquisition. Globally, Wells Fargo Bank, N.A. is the best at cross-sell of products. On an average, the US bank sells eight products per customer, while Indian public banks sell 1.5 products. Out of every 100 savings bank accounts, 40% decay within two years with very low cross-sell, as most public sector banks have not developed the right kind of analytics that can catch customer behaviour. A large branch network is of no use without this.
Another critical area is the payment space where non-banks are taking positions fast. The public banks must exploit the exponential growth of e-commerce and the increasing focus both by the government and the banking regulator on a cash-less economy, says Sambamurthy, who was till recently the director of the Institute for Development and Research in Banking Technology. They need to set payment factories quickly, covering the entire value chain— from card issuance, merchant acquiring, clearing and settlement, payment and transfer, e-commerce and online security to point of sales, mobile, ATM services, portals and gateways. Payment intermediation is very different from funds intermediation and if public banks do not move quickly, they may lose ground to payments banks and along with that, their retail deposit base and cross-sell opportunities. The Reserve Bank of India is expected to issue licences to the first set of payments banks soon.
Despite widespread cynicism about their expertise in project appraisal, risk management and monitoring, public banks enjoy enormous trust of people. That’s their biggest strength. Indeed, some of them need to shun the herd mentality which has led to large-scale infrastructure financing among other things and take a hard look at their business model, but beyond that, a few other things should be in place to change their profile: freedom to hire talent from the market and offer adequate compensation at the senior level; removal of the shadow of investigative agencies from genuine commercial decisions of bankers; a hands-off policy by the government; and making the CEO of a bank responsible to the board. These will lead to re-rating of public banks. On top of these, if the centre decides to park its stake in 27 public sector banks in a holding company, raising capital may not be a very difficult task.