09 Mar 2017 17:31 IST

Governance in PSBs is still a concern

Reforms, better oversight and tackling NPAs can help public sector banks fulfil their goals better

Globally, weakness in the banking system has been the cause for economic crises in many developed and developing countries. The Indian government has been making serious efforts to improve the competitiveness of our banks — primarily the government-owned public sector banks (PSB), which account for around 70 per cent of total banking operations.

Cumulative last quarter losses posted by the top 20 PBSs for the last year stood at around ₹15,000 crore. Although operational profits were reasonable, the provisions for non-performing assets (NPA) pulled down overall returns. Return on assets of PSBs is substantially lower than that of their private sector counterparts. With government being the majority shareholder in the PSBs, any losses heighten the need to capitalise the PSBs, which means a negative impact on fiscal consolidation in the economy.

NPAs are one of the biggest challenges faced by the PSBs; they have steadily increased over the last four years; the gross non-performing asset ratio touched almost 10 per cent in 2016. An apple-to-apple comparison with other emerging markets comes as a bit of a shocker; the corresponding number for China is less than 2 per cent!

Strengthening governance

The gross NPAs of PSBs stood at around ₹5,00,000 crore, while private sector banks contained the same at around ₹50,000 crore, this being 2.7 per cent of their total advances. Again, with large restructured loan accounts, the default risk is higher and can push up actual NPA levels in PSBs; these can account for an additional 3-4 per cent.

In the recent past, a number of initiatives have been taken to arrest the growing NPAs. The Insolvency and Bankruptcy Code, 2015 was introduced and some meaningful amendments to the Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest (Sarfaesi) Act, 2002 were effected. These important initiatives resulted in an incremental fall in NPAs in the recent past. Such stressed assets are a mere manifestation of weak executive management at banks. Although the NPA issue have to be addressed, the governance and executive management depth at PSBs needs immediate attention.

The most efficient way to tackle falling profitability and NPAs in the long term is by strengthening governance and executive management in PSBs that will position them more competitively against their private sector peers as well as global benchmarks. Eventually, over a period, this will translate into lower NPAs and higher return on assets.

Oversight lacking

To this end, an array of recommendations was made by the PJ Nayak committee, way back in 2014 to improve governance in PSBs. The report highlighted major gaps in PSB governance. Government control, inadequate operational freedom and government influence in appointing heads of PSBs affected their competitiveness.

Lack of executive management depth as well as absence of board oversight on strategic issues was revealed by the PJ Nayak panel report. The report specifically pointed out that board-level discussions on strategic issues were totally lacking; PSB boards, comprising government and RBI nominees, were not dedicating enough time to discuss ‘strategic’ issues while most of their conversations revolved around ‘day-to-day’ operational and tactical issues, said the report.

Especially because of government involvement, the leeway to offer compensation in line with private banks has been a major issue. Compensation paid to PSB heads has been really low; heads of private sector banks drew almost 20 times more in terms of compensation and additionally were entitled to stock options, which put them completely apart in terms of incentivisation, motivation and behaviour.

Governance reform

PJ Nayak recommended an intermediary holding company structure; the government’s shareholding in banks to be transferred to a bank investment company (BIC), which will eventually disintermediate government holdings in PSBs. It was perceived that through this structure, much required professionalism and independence can be brought into the PSBs.

Diluting equity in PSBs and allowing private players to take management control over a period of time could also become more conducive through this structure. With government still holding a majority stake, well above 50 per cent, and with poor capitalisation, there is enormous pressure on injecting more funds into the PSBs. Recent allocations by the government have been far below requirements and the banks have been asked to go for equity issue or sell non-core assets to increase capitalisation. That said, the holding company structure is inevitable and the government needs to move in this direction swiftly.

To be fair, over the last two years, the government did attempt to reform PSB governance, in line with the PJ Nayak panel recommendations. It has now separated the posts of chairman and managing director in many of the PSBs. The heads of the PSBs are today being nominated by the banks’ board bureau (BBB), but it is still widely believed that government interference has not ceased. A lot more needs to be done!

Financial inclusion

Only when a professional executive management system is in place, can these banks think strategically. This is important as the banking system needs to evolve swiftly and become stronger to enable increased banking penetration and financial inclusion, that supports rural and agricultural development, complements small and large corporates in their domestic and international aspirations and, above all, caters to the growing middle class.

Over the short to medium term, the country will need a few ‘super large’ banks (universal banks) which, by their sheer size and global presence, can deliver superior service at the lowest cost to a wide spectrum of customers. The country will also need a number of small but ‘specialised’ banks with specific customer or geographic focus, to precisely satisfy the varying needs of customer groups.

With many banks of different sizes and regional spread, and most of them not in good shape when it comes to governance as well as financial position, it is important for every PSB’s board to strategically plan where they would fit, in the above scheme of things! These require a strong and deep professional executive management capability, able oversight at the board level of the PSB as well as a lot of discussions and arriving at a consensus on how the PSB will strategically move in the short to medium term.

These discussions will lay the foundation of where the bank’s focus will be over the medium to long term that will make it competitive and also provide returns to its shareholders. Until we have a set up that clearly segregates the ownership from professional management, it is unreasonable to expect these kinds of discussions to take place.

In essence, what the government is doing today to tackle NPAs is very important. In parallel, it needs to expedite easing the structural bottlenecks to enhance quality of governance at all levels of the PSBs.