Setting realistic performance targets key to PSU bank recapitalisation

Targets set during the previous recapitalisation plan were too high, and banks weren't able to achieve them

The prime challenge for the Union government for its ambitious Rs 2.11 trillion recapitalisation plan would be to release funds to ailing public sector banks based on achievable performance standards.

The Union government may link capital infusion with performance targets to be met out by the banks. These parameters may include: rationalisation of branches, strict monitoring of large value loans, customer services standards, among others, as per a news report in The Economic Times.

Finance Minister Arun Jaitley had said, while announcing a Rs 2.11-trillion capital plan over two years in public sector banks, which includes Rs 1.35 trillion through recapitalisation bonds, that it will be accompanied by a series of banking reforms.

During the previous recapitalisation exercise too, the government had set performance targets for banks. However, as the targets set by the government were too high, banks were unable to achieve the performance standards.
 

During the first year of capital infusion under Indradhanush, the government had pumped in money despite banks missing the set targets prompting the Comptroller and Auditor General (CAG) to criticize the government’s exercise.

The Central government had announced Indradhanush plan in 2015 to infuse Rs 700 billion out of budgetary allocation in state-owned banks over four financial years to meet their capital requirements in a bid to remain compliant with Basel III norms - international standards for banks to deal with risk management.

For 2015-16, the government had earmarked 20% out of capital infusion of Rs 250 billion to public sector banks based on performance during three quarters of the financial year. The performance standards, to be maintained by banks for getting the remaining portion of the capital infusion, included efficiency of capital use, growth of both credit and deposits and reduction in the cost of operations. The banks were required to improve the return on assets and return on equity along with reducing overhead cost as proportion of total income. Banks were also supposed to diversify its businesses, improve non-performing assets management and improve financial inclusion. 

The government also directed the banks to sell non-core assets, shut down loss-making branches and curb employee benefits such as leave travel allowance as some of the strict milestones. Human resource initiatives, including skill development and efforts to conserve capital were some qualitative targets fixed by the government under Indradhanush.

“Audit noticed that this was not done and all funds were released on the basis of need following the Asset Quality Review by RBI… the entire capital was released to PSBs [public sector banks] without considering their achievement of any performance criteria which highlights the shift in approach by DFS [department of financial services],” the CAG’s performance audit report on recapitalization of public sector banks, released in July this year said.

Later in March 2016, the Ministry of Finance decided that 25 per cent of the capital to be infused in 2016-17 would be disbursed upfront and the balance 75 per cent would be disbursed based on achievement of quantitative targets by PSBs by the end of the financial year. It was specifically stated that banks which do not achieve the targets would not receive further funds. 

In July 2016, however, the Ministry of Finance altered its decision and announced it would release 75 per cent capital upfront and the remaining 25 per cent based on the benchmarks.

“The shift in upfront disbursement from the earlier intended 25 per cent to 75 cent has impacted the DFS objective of ensuring accountability for efficient and optimal use of capital,” the CAG had noted.

Following this, the government withheld around Rs 65 billion to 13 public sector banks (PSBs) in 2016-17 under the Indradhanush plan as none of the banks met the performance standards.

During 1993-94 and 1994-95, the Union government infused Rs 64 billion and Rs 43.6 billion respectively under the recapitalization plan through issuance of bonds carrying fixed coupon rates initially at the rate of 7.75 per cent per annum which was subsequently raised to 10 per cent. During the recapitalisation exercise, government had asked the banks to sign Memorandum of Understanding (MoU) with Reserve Bank of India indicating targets for reduction in Non-performing assets (NPAs), increase in earnings and profits and improvement in viability, use of upgraded technology, improvement in customer service, reduction in costs, among others.

The report of the working group on ‘Restructuring Weak Public Sector Banks’ under the chairmanship of former State Bank of India Chairman M S Verma noted in 2001 that the MoU exercise linked to capital infusion was not a fruitful exercise due to overambitious targets.

“The MOU exercise had only a limited success in improving the financials of the weak banks…It has also been observed that in order to improve the conditions at these banks at a faster pace they were mostly given performance targets which were quite high and by their standards rather stretched. In most cases, therefore, these targets were not met,” the working group noted.