On August 14, 2015, the ministry of finance released the Indradhanush framework for transforming the government owned public sector banks (PSBs), which are currently in a bad shape primarily due the bad loans that have piled up over the years.
In fact, the press release accompanying the announcement was extremely self-congratulatory in nature and pointed out: “Indradhanush framework for transforming the PSBs represents the most comprehensive reform effort undertaken since banking nationalisation in the year 1970. Our PSBs are now ready to compete and flourish in a fast-evolving financial services landscape.”
The framework has seven steps, and hence has been named Indradhanush or rainbow (which has seven colours). Enough has been written in the mainstream media regarding what these steps are. Hence, in this column I will concentrate on what is missing in the Indradhanush framework and why it is unlikely to help the public sector banks in a major way.
The third step in the Indradhanush framework talks about the government putting in Rs 70,000 crore into these banks over the next four years. Of this Rs 50,000 crore will be invested in the current and the next financial year.
There are a number of questions that crop here. The first question is whether this is going to enough? The PJ Nayak committee report released in May 2014 estimated that between January 2014 and March 2018 “public sector banks would need Rs. 5.87 lakh crores of tier-I capital.” The committee further said that: “assuming that the Government puts in 60 per cent (though it will be challenging to raise the remaining 40 per cent from the capital markets), the Government would need to invest over Rs. 3.50 lakh crores.”
The government on the other hand estimates that “the capital requirement of extra capital for the next four years up to FY 2019 is likely to be about Rs.1,80,000 crore.” Of this amount it proposes to invest Rs 70,000 crore.
In a research note titled A Growing Need for Indian TARP, Anil Agarwal, Sumeet Kariwala and Subramanian Iyer, analysts at Morgan Stanley, estimate that an immediate infusion of around $15 billion (or Rs 97,500 crore assuming $1 = Rs 65) is needed in these banks.
The international rating agency Standard & Poor’s said: “The Central government’s planned capital infusions come at a good time for public sector banks. But they don’t go far enough.”
So, the government is clearly not investing as much as the public sector banks really need to get out of the current mess that they are in. Further, as I have pointed out in the past, the government putting in more money into public sector banks goes totally against the “minimum government maximum governance” philosophy that Narendra Modi had espoused in the run-up to the Lok Sabha elections that happened last year.
This does not mean that the government should abandon these banks. But there is no reason that it should own 25 public sector banks, especially given that they require a massive amount of money to continue functioning. It is best to own five or six big banks and sell out of the others. In this way it will be able to concentrate its efforts on managing the big banks. At the same time, it will get more bang for the buck on the money that it is putting into the public sector banks.
This brings me to the next point I want to make. There is nothing in the Indradhanush framework that talks about the government trying to sell its stake in the public sector banks. Many public sector banks have a very good branch network in place and hence, will be attractive buys despite their balance sheets being in a mess.
This non-reference to disinvestment is not surprising given that it will be a politically very difficult thing to do. And from whatever evidence we have had from the Modi government up until now, it has shown no zeal to push through politically difficult reform. Given this, the government will continue to own 25 banks and hence, it is likely to pump more tax payer money into these banks in the days to come, because Rs 70,000 crore is clearly not going to be enough.
The fourth point in the Indradhanush framework talks about de-stressing public sector banks. The press release has a long-winded paragraph written in a fine bureaucratic way which comes up with practically every possible reason to explain the bad loans that have piled up with public sector banks.
Here it goes (you won’t miss much if you decide to skip it): “Due to several factors, projects are increasingly stalled/stressed thus leading to non-performing assets(NPAs) burden on banks. In a recent review, problems causing stress in the power, steel and road sectors were examined. It was observed that the major reasons affecting these projects were delay in obtaining permits / approvals from various governmental and regulatory agencies, and land acquisition, delaying Commercial Operation Date (COD); lack of availability of fuel, both coal and gas; cancellation of coal blocks; closure of Iron Ore mines affecting project viability; lack of transmission capacity; limited off-take of power by Discoms given their reducing purchasing capacity; funding gap faced by limited capacity of promoters to raise additional equity and reluctance on part of banks to increase their exposure given the high leverage ratio; inability of banks to restructure projects even when found viable due to regulatory constraints. In case of steel sector the prevailing market conditions, viz. global over-capacity coupled with reduction in demand led to substantial reduction in global prices, and softening in domestic prices added to the woes.”
There is no mention of how the banks are going to go about recovering the loans that they have given out and which are not being repaid. As an editorial in The Financial Express points out: “The lack of a concrete plan to tackle NPAs is worrying. There is no mention of how the debt of state electricity boards (SEBs), running into several lakh crore rupees, is going to be recovered or that from wilful defaulters or highly-leveraged promoters.”
Further, many measures that the government has listed out as a part of the Indradhanush framework have already been around for a while now, having been put in place by the Reserve Bank of India.
The fifth point in the Indradhanush framework talks about “no interference from government,” in the functioning of banks. It further states that “banks are encouraged to take their decision independently keeping the commercial interest of the organisation in mind.”
How are banks supposed to interpret this point given that in his Independence Day speech Prime Minister Narendra Modi talked about “Start-Up India, Stand-Up India”. The idea, as Modi explained during the speech, is that each of the 1.25 lakh bank branches all across India “should encourage at least one Dalit or Adivasi entrepreneur, and at least one woman entrepreneur”.
So how independent does this make the banks, given that they have to follow diktats like these from the government? Also, it is worth mentioning here that lending to start-ups is a very high risk kind of lending. Further, do public sector banks have the capability to analyse the loan proposals of start-ups, is a question worth asking here.
To conclude, it is safe to say that the Indradhanush framework is essentially a clever repackaging of steps and processes that are already in place. It is not the sanjivini booti that it is being made out to be.
The column originally appeared in The Daily Reckoning on August 20, 2015