Not recap alone

Budget could be a good starting point for deeper banking reforms

The Indian economy continues to recover from the Covid-induced shutdown and the upcoming Union Budget is expected to make policy interventions to strengthen the recovery. One of the important enablers of broader economic recovery would be the state of the banking system, particularly public-sector banks (PSBs). Since non-performing assets in the banking system are expected to rise due to Covid-related disruptions, the government will be expected to make an adequate allocation for capital infusion into PSBs. However, it’s not difficult to argue that allocating capital would not be easy for the government because of other pressing needs of the economy. Thus, the government should do more than just infusing capital into PSBs.

Pumping in capital — year after year — has not yielded the desired results. The Comptroller and Auditor General (CAG) has reportedly asked for details of PSB performance over the last five years after their recapitalisation. Given the persistent fiscal constraints, this could help ascertain the opportunity cost of PSB recapitalisation. This line of enquiry by the CAG should be welcomed because it will broaden the policy debate not only on the current state but also the future of PSBs. As things stand today, the government has infused capital worth over Rs 3.5 trillion into PSBs between 2015-16 and 2019-20 through equity and recapitalisation bonds. However, the market capitalisation of PSBs is just a tad above Rs 4 trillion. In fact, it was less than the amount infused until recently, which shows the kind of value destruction that has happened on PSB counters. This clearly suggests that the status quo is untenable and reforms would be needed to ease the fiscal pressure.

In this context, as reported by this newspaper, the government is considering the idea of a Bank Investment Company (BIC) in the Budget. In the given circumstances, this would be a right step. It would also require amending the Bank Nationalisation Act and the State Bank of India Act. The idea was recommended by the P J Nayak Committee in 2014. The government can set up a BIC under the Companies Act, which will hold the equity stake held by the government. The committee also recommended that the government sign an agreement with the BIC, which will give it autonomy and set the objectives in terms of financial returns from banks that it will control. This would, in a way, free PSBs from government control and allow them to operate more professionally. It would also help boost valuations and enable PSBs to raise capital from the market. The BIC itself can raise capital with private participation.

The BIC might also be a better option at this stage because it will be difficult to privatise PSBs and the government is not in a position to keep infusing capital perpetually. However, this idea will work only if the government is willing to give up control. The experiment with the Banks Board Bureau, another recommendation of the Nayak committee, hasn’t been inspiring so far. If the BIC too acts as an extension of the government, it will not achieve the stated objectives. Therefore, the government will need to give full autonomy to the BIC and appoint professional management. Essentially, the government needs to think beyond just putting capital in PSBs. The Budget next month would be a good starting point.