EDIT: PNB AND THE PSU BANKS
Message from market: We will support if the govt brings in credible leadership, changes the incentive structure, and fortifies the board
Everyone is wringing their hands on the jeweller Nirav Modi fraud and the damage it has caused to Punjab National Bank (PNB) and the PSU banks in general. While we still do not have all the facts, the fraud seems to be of an astonishing scale (somewhere between ~110 billion and ~200 billion) and audacity. There seems to have been a total breakdown of systems, controls, and process. How could this have gone on for so many years? What were the auditors, the Reserve Bank of India (RBI), and management of these banks doing? We may never learn the full truth, but it has exposed real weakness and deficiencies in the Indian banking system. The whole episode has also captured the media’s attention and will hopefully put pressure on all the parties concerned to face up to the need for change. There are two reasons why we need to act today.
First, the argument that we can just ignore the weaker PSU banks, they will wither away and we can fund India’s growth through the bond markets, non-banking financial companies (NBFCs), and private banks does not make sense. We need the PSU banks to be able to function. We cannot just wish away the PSU problem.
At the first signs of macro stress, inflation rising and liquidity tightening, the bond markets have seized up. Yields have risen by 150 basis points (bps) and the markets are temporarily broken. The PSU banks are on a buyers strike, sitting on an excess statutory liquidity ratio (SLR), with deposit growth slowing as cash in circulation rises, they do not want to buy any bonds. The mutual funds, sitting on losses, are now worried about redemptions rather than inflows from fixed income products. Given losses as yields have risen and the risks on the rupee, even foreigners are hesitant to buy Indian bonds in size. There is no buyer and eventually Life Insurance Corporation of India (LIC) will have to come in to support the borrowing programme of the government. The fixed income markets on their own cannot support the credit needs of the country, either directly through corporate bond issuance or even indirectly by funding the NBFCs. We may eventually have robust enough fixed income markets to supplant the banking system, but we are not there yet. We need a robust banking system (PSU banks still account for 60 per cent of system assets) which can fund borrowers of all shapes and sizes. This will become even more apparent as credit picks up.
Second, the macro costs of keeping the banks afloat are not trivial. While there is limited direct cost of the ~2.1-trillion recapitalisation plan, just interest costs, it does lead to a build up in government debt. The markets will not support these banks in their present state, and thus the government will remain on the hook. Given different assumptions on the extent of the haircuts banks need to take on their bad assets, we may need another bank bailout of between ~2 trillion and ~3 trillion. These are huge numbers and keep rising. Given the poor profitability of the PSU banks, with return on assets of less than 50 bps, they have no ability to self generate enough capital to fund growth. They will be forever reliant on the government for funding. We have to stem the bleeding at some stage and the government has to stop being the backstop. We do not have the fiscal capacity to support an open-ended commitment to these banks.
So what to do? Everyone recognises that something has to be done, but what? The knee-jerk reaction is that we have to privatise. Do not waste a crisis. Now is the time. There is so much public disgust, and the beginnings of a lack of trust in certain PSU banks that we can push through change in ownership. While privatisation, if possible, would make sense and be the obvious choice, there are some caveats. The political will still does not seem to be there, and in the absence of this willingness all talk of privatisation is purely theoretical. We may debate why we hesitate to privatise and the political arguments for holding it back, but that is material for a separate article. The fact remains that no government has had the guts to reverse the nationalisation of 1969, and this government will face elections in 14 months. Second, privatisation on its own is not necessarily a panacea. We have had cases like Global Trust Bank in the private sector also, a total fraud.
At its core the PSU bank issue is an organisational transformation challenge, with HR being the core issue. We pine for private ownership so that these banks can recruit lateral talent into specialised positions and pay market-based compensation. We want to avoid the bogey of directed lending based on political connections. We need the officers of these banks to take commercial decisions without the fear of the three Cs (Central Vigilance Commission, Comptroller and Auditor General, and Central Bureau of Investigation). We need more accountability and a performance-based culture. Given the crisis facing the PSU banks and the extent of damage it can cause to the economy we need to make critical changes. The government had created the Banks Board Bureau (BBB) to address exactly these challenges. If allowed to function it would have been the catalyst to engender this needed cultural change and bring in top quality talent at both an executive and board level. Why was the experiment of bringing in private sector leaders into the banks at both CEO and chairman level not repeated after Bank of Baroda (BoB)? Unfortunately the BBB has never been taken seriously by the powers that be. Instead of pining after privatisation, let us at a minimum get the BBB to function, bring in new talent, and start the process of repair. There are various recommendations the BBB has made on training, leadership development and compensation. At least implement these changes. The only other PSU bank the markets will fund beyond State Bank of India (SBI) is BoB and that is because of the management change. The message from the market is clear. Bring in new credible leadership, change the incentive structure, fortify the board and we will support and fund. In the absence of these changes the government will be on its own, throwing more and more money down a black hole.
Also given the talent gap, let us also reduce the number of PSU banks. Do we need so many? Let us have SBI and BoB as pan-India banks and then maybe four more which are more regional in nature. Do we really need more than six?
While privatisation may be the end goal, at least begin the process of repair today by fully utilising the BBB structure and its recommendations.
The writer is with Amansa Capital