Indradhanush Framework: A Missed Opportunity For The Modi Government

Earlier this month, the ministry of finance recently came up with the seven step Indradhanush framework to transform the shape of the government owned public sector banks (PSBs). As the press release accompanying the announcement of the framework pointed out: “Indradhanush framework for transforming the public sector banks 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.”

Given the marketing prowess of the Narendra Modi government, such a claim isn’t surprising. Nevertheless, the question is, does the framework address the basic issues at the heart of reforming the public sector banks.

In May 2014, the Committee to Review Governance of Boards of Banks in India (better known as the PJ Nayak Committee) had submitted a detailed report on reforming the public sector banks in India.

As the report submitted by the PJ Nayak committee pointed out: “Governance difficulties in public sector banks arise from several externally imposed constraints. These include dual regulation, by the Finance Ministry in addition to RBI; board constitution, wherein it is difficult to categorise any director as independent; significant and widening compensation differences with private sector banks, leading to the erosion of specialist skills; external vigilance enforcement though the CVC and CBI; and limited applicability of the RTI Act. A more level playing field with private sector banks is desirable.”

The committee had also proposed a solution to these problems. As it said: “If the Government stake in these banks were to reduce to less than 50 per cent, together with certain other executive measures taken, all these external constraints would disappear. This would be a beneficial trade-off for the Government because it would continue to be the dominant shareholder and, without its control in banks diminishing, it would create the conditions for its banks to compete more successfully. It is a fundamental irony that presently the Government disadvantages the very banks it has invested in.”

There is nothing in the Indradhanush framework which talks about either privatisation or the government bringing down its stake to lower levels in public sector banks. The Modi government like the previous Manmohan Singh government wants to continue owning 25 public sector banks. Also, by wanting to own 25 public sector banks, the government has gone 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.

The Nayak committee had also proposed that the government follow the Axis Bank model, where the government is an investor rather than the promoter. “The CEO is appointed by the bank’s board, and because the bank was licensed in the private sector, it sets its own employee compensation, ensures its own vigilance enforcement (rather than being under the jurisdiction of the Central Vigilance Commission), and is not subject to the Right to Information Act.”

The Nayak committee had also talked about the need to do away with the dual regulation of public sector banks by the ministry of finance as well as the Reserve Bank of India. This, the committee had said makes public sector banks uncompetitive. As the report of the committee had pointed out: “Any directions issued which are applicable to a subset of banks do damage to that subset, however laudable the objectives. Those banks not part of the subset are under no obligation to participate; if they do so the participation is voluntary, while for the subset it is coercive. Such discriminatory orders reduce the competitiveness of the subset. It is ironical that the Government seeks to make uncompetitive the very banks it has invested capital in.”

An excellent example of this is the lending carried out by public sector banks to many infrastructure companies over the last few years, where the private sector banks had stayed away from lending. A major part of the bad loans on the books of public sector banks come from lending to infrastructure companies.
As DN Prakash, President of Corporation Bank Officers’ Organisation and Vice-President All India Bank Officers’ Confederation, said in a press release: “A major part of NPAs of PSBs are in infrastructure, power and telecom sectors. When private sector banks had stayed away, PSBs had lent to these sectors as part of their commitment to economic growth and nation building. Today, they are blamed for the NPAs in these sectors.”

In order to rule out such problems the Nayak committee had recommended: “The Government should cease to issue any regulatory instructions applicable only to public sector banks, as dual regulation is discriminatory. RBI should be the sole regulator for banks, with regulations continuing to be uniformly applicable to all commercial banks.”

But the Indradhanush framework does nothing on this front. The idea of giving away control over public sector banks is a little too difficult for babus and politicians to digest. On this front, the Modi government is not very different from the previous governments.

Further, the public sector need a lot of money in the years to come, which the government as the major owner has to provide. But it cannot do so without ending in a big financial mess itself.

The Nayak committee 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. Where is this money going to come from is a question that the government hasn’t tried to answer.

Over and above this, the Indradhanush framework does not come up with any fresh thinking on the issue of bad loans that has been plaguing public sector banks. It lists out a series of things that the Reserve Bank of India has been doing for a while now. But as is well know these steps haven’t done much to stem the rot when it comes to burgeoning bad loans.

As Prakash of Corporation Bank puts it: “there is no resolve on part of the Government to recover NPAs from big corporates that constitute the major chunk of NPAs [non-performing assets] in the industry.”

There doesn’t seem to be any systematic solution in light to clean up the bad loans mess at public sector banks. The government had an opportunity to do this with the Indradhanush framework, which it has clearly missed. As Crisil Ratings pointed out in a brief research note, “A ‘surgical’ response to the challenge of NPAs by creating a ‘bad bank,’” could have been a step in the right direction.

The column originally appeared on Swarajya Mag on August 26, 2015

(Vivek Kaul is the author of the Easy Money trilogy. He tweets @kaul_vivek)

On payment banks: Rajan is right, Bhattacharya is wrong

On August 19, 2015, the Reserve Bank of India (RBI) gave an approval to 11 entities to start “payment banks”. These include Vodafone, PayTM, Department of Post, Aditya Birla Nuvo, Reliance Industries, Airtel M Commerce, Vodafone m-pesa etc. As the name suggests, payment banks will be allowed to collect money from depositors and make payments to others, on their behalf.

These banks can accept deposits of up to Rs 1 lakh only. Further, they are not allowed to give out loans like normal banks are. A bulk of the deposits they collect need to be invested in government securities which mature in a period of up to one year.

So what is the idea behind setting up these banks? The simple answer is financial inclusion—to improve the penetration of the banking system in India. A recent World Bank report points out that between 2011 and 2014 the number of bank accounts in India increased by 17.5 crore, thanks to a massive push by the government. With this increase in numbers, the penetration went up from 35% to 53%. The worrying thing is that even after this massive increase, half of India does not have a bank account.

Further, the high dormancy rate is another worrying factor. As the World Bank report points out: “India, with a dormancy rate of 43 percent, accounts for about 195 million of the 460 million adults with a dormant account around the world.”

The hope is that payment banks will help address this problem to some extent.  As the Draft Guidelines for Licensing of “Payments Banks” document points out: “There is a need for transactions and savings accounts for the underserved in the population…Higher transaction costs of making remittances diminish these benefits. Therefore, the primary objective of setting up of Payments Banks will be to further financial inclusion by providing (i) small savings accounts and (ii) payments / remittance services to migrant labour workforce, low income households, small businesses, other unorganised sector entities and other users, by enabling high volume-low value transactions in deposits and payments.”

The RBI governor Raghuram Rajan has been a driving force behind these banks and sees them as a game-changer. Nevertheless, the existing banks are not looking forward to the competition that these new banks will bring in.

As Arundhati Bhattacharya, chairperson of the State Bank of India said recently: “Why this payments bank is a little worrisome is because they will be allowed to have savings deposits. What if they go for poaching rates, then many of the commercial banks could lose a portion of the deposits which are relatively lower priced so that will take away the ability to transmit rates and give further loans at lower rates.”

What Bhattacharya is worried about is that the new payment banks will try and attract savings deposits at a higher rate of interest. Most big banks currently pay around 4% on deposits on their savings accounts. It is a cheap source of funding for them.

The payment banks will offer higher rates of interest on deposits, Bhattacharya feels. This is a possibility. The question is how high? The payment banks are not allowed to give out loans. Further, they are allowed to invest only in government securities of up to one year. Also, they are supposed to maintain a cash reserve ratio of 4% with the RBI. On these deposits no interest is paid. If all these factors are taken into account, the payment banks cannot go overboard with offering very high rates of interest on deposits, if the idea is to make profits.

As Rajan said in response to Bhattacharya: “I don’t think these 11 new banks are a threat to the existing banks. These new banks will complement the existing system by traversing the last mile. The reason for this is that there is nothing the universal banks cannot do that the payments banks can do. But there are some of the things that the payments banks can’t do which the universal banks can.”

What Rajan meant here was that payment banks unlike scheduled commercial banks cannot give out loans. And that limits their ability to make profits. And given that they cannot go overboard while offering a higher rate of interest to attract deposits.

Another fear that has been raised is that people will move their money from scheduled commercial banks to payment banks in order to be able to pay electricity/telephone bills etc. The point is that people are already using services offered by scheduled commercial banks to pay such bills. Hence, there is no real reason for them to move on to a payment bank, lock, stock and barrel.

If we might just rephrase what Rajan said: “A scheduled commercial bank can do everything that a payment bank can do.” In fact, a lot of them already have the necessary infrastructure in place to do things that payment banks are likely to do.

Also, banking in cities and urban areas is pretty much stagnated. The low hanging fruit has more or less been taken. If payment banks want to attract deposits, they need to look beyond the middle class, and look at the urban poor as well as the rural areas to attract deposits.

Anybody who has read Rajan’s first book Saving Capitalism from the Capitalists (co-authored with Luigi Zingales) would know where his thinking is coming from. In this book Rajan explains in great detail as to how the only way to develop finance is to increase competition. As he writes along with Zingales: “Finally, and perhaps most important, increased competition resulting from forces beyond control of incumbents—in particular, competition as a result of technological changes…—can reduce incumbents’ incentives to use financial underdevelopment as a barrier to domestic entry.”

What does this mean in the context of payment banks? Payment banks will bring in increased competition through forces that are beyond the control of incumbents i.e. the scheduled commercial banks. Further, payment banks are likely to use a lot of technology in their bid to expand the market. This will keep the scheduled commercial banks on their toes.

Rajan is hoping that payment banks will bring in a new way of doing things. As he said last week: “The bank branch can become a centre of activity, helping with cash handling or do some completely new work…There is a lot of scope for everyone… not everybody will succeed but this is a revolution which can happen.”

Further, if these banks end up expanding the banking penetration of the country, Bhattacharya’s fear of interest rates going up, will not hold true. If payment banks are able to expand the total deposit base of the country at a faster rate than the current rate, the interest rates are likely to come down.

So, why did Bhattacharya react the way she did? Rajan and Zingales have an explanation for that in their book. As they write: “Throughout its history, the free market system has been held back, not so much by its own economic deficiencies as Marxists would have it, but because of its reliance on political goodwill for its infrastructure. The threat primarily comes from…incumbents, those who already have an established position in the marketplace…The identity of the most dangerous incumbents depends on the country and the time period, but the part has been played at various times by the landed aristocracy, the owners and managers of large corporations, their financiers, and organised labour.”

Bhattacharya runs the biggest bank in the country, the State Bank of India. And given that she is an incumbent, and incumbents don’t like increased competition. It tends to disrupt their existing business model. Hence, her reaction was not surprising.

(Vivek Kaul is the author of the Easy Money trilogy. He tweets @kaul_vivek)

The column originally appeared on on August 25, 2015

Home Prices, And Not Buyers, Are Unrealistic

India-Real-Estate-MarketVivek Kaul

Columnist Gautam Mukherjee wrote an article on real estate published on this website on August 3, 2015. In this column Mukherjee had this to say about prospective buyers looking to buy a home to live-in: “These worthies [i.e. the prospective buyers], expecting a crash in prices as the crisis deepens, are gleefully seeking ever more unrealistic bargains before committing themselves. To them, the builders are profiteers, bloated on black money, and unethical, one-sided, contractual arrangements.”

I really wonder why prospective buyers have been called “worthies” here. And what is wrong about hoping to find a home to live in at a price which one can afford? Further, are the prospective buyers really seeking “unrealistic bargains” or are home prices at unrealistic levels? From all the data that is available it seems to be the latter.

Data put out by real estate research and rating firm Liases Foras tells us that the weighted average price of a flat in a city like Mumbai was Rs 1.3 crore as of March 2015. In the National Capital Region it is Rs 74 lakh. In Bangalore the price is Rs 86 lakh. And so is the situation almost all over the country.
I would like to ask Mr Mukherjee, among the people who he calls “worthies”, how many make the kind of money that is needed to be able to afford these homes? Let’s do some back calculation and see.

The weighted average price of a flat in Mumbai is Rs 1.3 crore. A bank would finance 80% of this. This means that the bank would give a home loan of up to Rs 1.04 crore. The remaining Rs 26 lakh the prospective buyer would have to arrange as a down-payment. This assuming that the builder does not ask for any payment to be made in black. I know that this is an unrealistic assumption, but just humour me for a bit.

The State Bank of India currently charges an interest of 10% on home loans above Rs 1 crore. For a twenty year loan the EMI works out to Rs 96,502. Typically, while lending banks ensure that up to 40% of the salary goes towards the EMI. Hence, to get a loan of around Rs 1.04 crore and to be able to pay an EMI of Rs 96,502, the salary of the borrower has to be around Rs 2.41 lakh per month(Rs 96,502 divided by 40%) or around Rs 29 lakh per year (Rs 2.41 lakh multiplied by 12).

Even in Mumbai how many people make that kind of money? The Maharashtra State Economic Survey for the year 2014-2015 points out that the average per capita income in Mumbai during 2013-2014 stood at Rs 1.88 lakh. So it’s not the “prospective buyers” who are being unrealistic, it’s the prices that builders want to be paid for the homes that they have built, which are unrealistic.

Given this, it is not surprising that, as the latest Economic Survey points out: “At present urban housing shortage is 18.8 million units [i.e. homes].”

As mentioned earlier Mukherjee writes: “To them [prospective buyers], the builders are profiteers, bloated on black money, and unethical, one-sided, contractual arrangements.”

What is wrong with this thinking? As analysts Saurabh Mukherjea and Sumit Shekhar of Ambit write in a recent research report titled Real Estate: The unwind and its side effects: “Another big source of generation of black money is the real estate sector which has witnessed an unprecedented boom in the past ten years or so. In Delhi, the ratio of unaccounted value of real estate transactions to the total value is as high as 78%. The same ratio is 50% in Kolkata and Bangalore. In smaller towns and semi urban centres, nearly 100% of property transactions are conducted in cash.” In Mumbai, they put the ratio of black money to total value at between 10-30%. The Ambit analysts were quoting from data put out by National Institute of Public Finance and Policy in July 2014.

I guess Mukherjee may not want to believe this. So here is something out of a report on black money published by the business lobby FICCI in February 2015. As the report points out: “The Real Estate sector in India constitutes for about 11 % of the GDP of Indian Economy, as these transactions involve high transaction value. In the year 2012-13, Real Estate sector has been considered as the highest parking space for black money.” FICCI is a business lobby and not an association of buyers looking to buy homes to live-in. Given these things Mukherjee’s sarcasm towards prospective buyers who cannot afford homes at their current prices, was really uncalled for.

In the example considered above the weighted average price of a flat in Mumbai is Rs 1.3 crore. If the builder asks 20% of this in black (and I am being fairly conservative here), the prospective buyer has to arrange for Rs 26 lakh.

This leaves Rs 1.04 crore, which becomes the price of the flat on which the bank will give a home loan. Now remember, the bank gives a home loan of up to only 80% of the price of the flat. Hence, the bank will give a loan of up to only Rs 83.2 lakh. The remaining Rs 20.8 lakh would have to be paid by the buyer as a down-payment. This means that the buyer needs savings of at least Rs 46.8 lakh(Rs 26 lakh paid in black plus Rs 20.8 lakh to be paid as a down-payment) to buy a flat. How many people have savings of this kind?

And Mumbai has low levels of black money required to buy a home in comparison to other cities. So, if prospective buyers see builders as profiteers who are bloated on black money, there is absolutely nothing wrong with that. Further, many builders have just taken money from buyers and disappeared. There are many others who have endlessly delayed projects. Hence, if other buyers look at them in a negative light, you can’t blame them for it.
Mukherjee further asks: “But what is the government, specifically the RBI and Finance Ministry doing about the high interest rates, the recapitalisation of banks, and renegotiation of all the stressed loans to builders/ industry, which are about to become irretrievable NPAs?.”

He also suggests: “Also, in the interim, the assumption is that the construction industry will receive new lines of credit/ rescheduled debts from the banks and lending institutions to finish their half-built projects.”

The tone is that the government and the banks should come to the rescue of the real estate companies which are in a mess. There are multiple points that need to be made here. First and foremost why can’t builders cut home prices and sell the massive number of unsold homes that they are sitting on.

Second, why should banks lend more to a borrower who is unable to repay his past debt? It is important to understand the main purpose of a bank, which is to ensure that the money deposited by individuals with it, remains safe and earns some return in the process. What Mukherjee is suggesting is that banks throw good money after bad. Why? Just because a few builders are going to go bust?

Also, it is worth asking where did all the money that the builders raise for building projects go? They took money from prospective buyers. They took money from banks. Where did all this money go? Guess Mukherjee can give us an answer for that.

Further, the builders have made potloads of money between 2002 and 2013, when the bull run in real estate drove home-prices to the current unrealistic level. So how is it fair that prices were allowed to rise, but now when the prices are falling (or should be falling), they should not be allowed to fall?

John Kenneth Galbraith, who was probably the most read economist in the mass media in the twentieth century, once said: “In America, the only respectable type of socialism is socialism for the rich.” Mukherjee along these lines wants the government to bailout the builders. I am no capitalist but socialism for the rich, is socialism of the worst kind.

(Vivek Kaul is the author of the Easy Money trilogy. He tweets @kaul_vivek)

The column originally appeared on SwarajyaMag on Aug 5, 2015