Pri­vatis­ing PSBs isn’t easy

Business Standard - - OPINION - TT RAM MO­HAN

If a week is a long time in pol­i­tics, a month or two can be a long time in eco­nomic pol­icy. Two months ago, fol­low­ing the Pun­jab Na­tional Bank (PNB) fraud, an enor­mous clam­our had erupted in favour of pri­vati­sa­tion of pub­lic sec­tor banks (PSBs). With ICICI Bank and Axis Bank in the news for the wrong rea­sons in re­cent weeks, the clam­our has died down quite a bit.

Con­spir­acy the­o­rists say that was the whole point about turn­ing the spot­light on two large pri­vate banks — to de­flect at­ten­tion from the prob­lems at PSBs. Con­spir­acy or no, the is­sues of gov­er­nance that have arisen at the two pri­vate banks do have im­pli­ca­tions for pri­vati­sa­tion of PSBs.

Pri­vati­sa­tion is all about en­sur­ing greater man­age­ment ac­count­abil­ity for per­for­mance. This is en­sured by boards of di­rec­tors that fo­cus res­o­lutely on share­holder value. At PSBs, the ar­gu­ment goes, boards are nowhere as ef­fec­tive as politi­cians and bu­reau­crats in­flu­ence de­ci­sions from be­hind the scenes.

Well, that’s the the­ory. The prob­lems at two large pri­vate banks have re­in­forced doubts about how well boards in pri­vate com­pa­nies per­form in prac­tice. At ICICI Bank, the board failed to re­spond ad­e­quately to charges of con­flict of in­ter­est. At Axis Bank, the board of­fered a fourth term to the chief ex­ec­u­tive of­fi­cer (CEO) in the face of what an­a­lysts viewed as in­dif­fer­ent per­for­mance and then chose to back­track when ques­tioned by the Re­serve Bank of In­dia (RBI). Nei­ther board is a great ad­ver­tise­ment for board ef­fec­tive­ness.

You could ar­gue that even if boards are not ef­fec­tive enough, in­cen­tives at pri­vate banks will still pro­duce su­pe­rior out­comes. Man­agers at pri­vate banks will de­liver per­for­mance be­cause they stand to be richly re­warded through bonuses and stock op­tions. ICICI Bank and Axis Bank may have fal­tered in re­cent years but they have still fared bet­ter than most PSBs.

Alas, get­ting the in­cen­tives right is also a func­tion of the board. Weak boards that are in thrall to CEOs will hand out re­wards un­re­lated to per­for­mance. This is bound to tell on long-term per­for­mance.

The im­pli­ca­tion should be ob­vi­ous enough. We can’t pri­va­tise PSBs in the hope that this will au­to­mat­i­cally lead to su­pe­rior out­comes. We need to un­der­stand the con­di­tions under which pri­vati­sa­tion will pro­duce re­sults in our con­text. To be­gin with, it’s use­ful to grasp a cou­ple of facts about pri­vate banks in In­dia.

First, ICICI Bank and Axis Bank are both of gov­ern­ment parent­age. The early suc­cess of these banks owed to the trust and con­trols that are as­so­ci­ated with gov­ern­ment banks. It is only over time that they came to shed their pub­lic sec­tor char­ac­ter and be­came in­creas­ingly board-driven. The ex­pe­ri­ence with these two banks sug­gests that, in In­dia, the board-driven model may pro­duce re­sults ini­tially but could run into se­ri­ous prob­lems over time.

Se­condly, the banks that have been com­pletely pri­vate sec­tor in char­ac­ter from the word go and are far­ing well to­day — Ko­tak Mahin­dra Bank, YES Bank, In­dusInd Bank — all have a dom­i­nant in­vestor. So does HDFC Bank, al­though it, too, is of semi-gov­ern­ment parent­age.

A fair in­fer­ence is that In­dia has a long way to go be­fore it de­vel­ops a cul­ture of pro­fes­sional boards ac­count­able to in­sti­tu­tional in­vestors. The model that is work­ing bet­ter to­day in pri­vate banks is one where a dom­i­nant in­vestor calls the shots.

It won’t do, there­fore, for the gov­ern­ment to drop its eq­uity stake be­low 50 per cent and hand over mat­ters to pro­fes­sional boards, as the P J Nayak Com­mit­tee on bank gov­er­nance had rec­om­mended in 2014. The Nayak Com­mit­tee saw Axis Bank as the role model for other PSBs to fol­low. One is not sure that the Nayak com­mit­tee would think so to­day.

At any rate, an­a­lysts and in­vestors are un­likely to rel­ish the prospect. The model that will en­thuse them is one with a dom­i­nant pri­vate in­vestor, some­body with “skin in the game”. Since reg­u­la­tions do not al­low for­eign own­er­ship to ex­ceed five per cent in gen­eral, the dom­i­nant in­vestor would have to be an In­dian in­dus­trial house or one of the pri­vate banks with a dom­i­nant in­vestor.

Giv­ing a bank li­cence to an in­dus­trial house poses se­ri­ous sys­temic risks: The RBI did not give a bank li­cence to any in­dus­trial house in the last round. As for pri­vate banks tak­ing over PSBs, it’s not clear they would be keen to do so. The bet­ter ones are do­ing well enough through or­ganic growth. They are likely to find the hu­man re­source is­sues en­tailed by the ac­qui­si­tion of a PSB daunt­ing.

It’s hard to re­sist the con­clu­sion that the con­di­tions for pri­vatis­ing PSBs are not in place to­day. Sim­ply let­ting go of gov­ern­ment con­trol and leav­ing mat­ters to boards risks cre­at­ing a dan­ger­ous gov­er­nance vac­uum at PSBs. There is, there­fore, no re­al­is­tic al­ter­na­tive to re­form­ing and strength­en­ing PSBs under gov­ern­ment own­er­ship. It is iron­i­cal that the po­lit­i­cal class seems to have grasped this re­al­ity while those mock­ing it for not em­brac­ing “big bang” re­form haven’t.

The writer is a pro­fes­sor at IIM Ahmed­abad

Dis­clo­sure: The writer is on the board of In­dusInd Bank. Views are the au­thor’s alone

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