Six suggestions for the new finance minister

Some unsolicited advice for a government with brute majority and nation's pragmatic chief money man

We have a rock-solid government at the Centre for the next five years. And a pragmatic governor at the central bank, a doer. The combination encourages me to put on the table half a dozen unsolicited suggestions before the new finance minister. Some of them may sound radical but then the Bharatiya Janata Party-led government is decisive and on a mission mode. 

Privatise public sector banks: Under the Banking Act, the Indian government needs to hold at least 51 per cent of the paid-up capital in such banks. Besides direct government holding, the Life Insurance Corporation of India holds significant stakes in such banks and a few public sector undertakings, including some of the peer banks, cross-hold PSB shares, ensuring indirect but complete government ‘control’ over all PSBs.

Let’s change the Act and privatise some the PSBs. In past two years, the government has infused close to Rs 2 trillion to keep the ailing PSBs afloat. Historically, the government has pumped in Rs 3.5 trillion, a bulk of which (some Rs 3.3 trillion) has flown in since 2009. How much money would the government have made had it invested this sum in Bank Nifty? 

A panel has recommended creation of a holding company for all PSBs by transferring the government’s stake to it to run them efficiently and create value. This may not work as it’s difficult for the government to let loose its control. Consolidation (which has started with merger of three PSBs) will not solve the problem. The government-owned banks don’t need to have close to 70 per cent share of banking assets. To start with, let some of the smaller PSBs be privatised. The government will not make money selling its stake but save enormous amount of tax payers’ money.

Abolish priority sector loan norms: All commercial banks (including foreign banks operating in India) need to channel 40 per cent of their loan assets to the so-called priority sector, consisting of small business units, farmers and so on. The definition of the sector changes periodically. Most banks fail to meet the target; they lend money to microfinance institutions to be on-lent to these segments or invest in certain bonds as stipulated by the Reserve Bank of India (RBI). Indeed, there is need to finance such segments but why not do it directly through the National Bank for Agriculture and Rural Development (Nabard), Small Industries Development Bank of India (Sidbi) and even National Housing Bank (NHB). Two of the three are refinance agencies with some regulatory responsibility thrown in. Let them meet the financial needs of the farmers, small entrepreneurs, low-cost housing and the so-called have-nots and free up the banking system to lend to the private sector.

Illustration: Binay Sinha

Put NHB to sleep: Why should we kill NHB? Is this because a few large mortgage companies are in trouble? If this is the reason, shouldn’t the RBI too close its shop because of a crumbling non-banking finance company (Infrastructure Leasing & Finance Company Ltd) and a very large public sector bank being hit by the biggest fraud in banking industry (Punjab National Bank)?

No. The reason for setting up NHB in July 1988 was the creation of the mortgage market in India when banks were not giving home loans, fearing asset-liability mismatches. The NHB’s mandate was to find ways of long-term finance needed for home loans and create a housing finance market. It has served the purpose and it’s time to put it to sleep. 

The RBI which had contributed the entire capital (Rs 1,450 crore), divested its stake in NHB in March. Over a period of time, a few powerful housing finance companies (HFCs) almost captured the regulatory role of NHB, turning it into a mere refinance agency. To complicate the problem, it has been liberal in giving licences — now there are 98 HFCs, double the number three years ago.

Look at the arbitraging the HFCs have been doing with dexterity. They take long-term cheap refinance from NHB and lend the money to the realtors. The NHB Act merely says an HFC should have a major portion of home loan assets to get the refinance but doesn’t specify how much. This blurs the dividing line between a non-banking finance company (NBFC), regulated by the RBI, and an HFC, regulated by the NHB. And both the regulators cannot make joint inspections of the books of HFCs and NBFCs.

Look at the NHB website to get a feel how it penalises HFCs for violating norms. On August 9, 2018, it penalised Dewan Housing Finance Corp Ltd, a deposit-taking large HFC, a princely sum of Rs 6,500 for non-compliance with the provision of para 27(2) of NHB directions 2010. What’s this para all about? An asset cannot be upgraded merely by rescheduling “unless it satisfies the conditions required for the upgradation”.

The NHB Act allows an HFC to restructure a bad asset only once, but with board approval. In this case, it was done without the board approval. The entire world is aware that till recently the trinity of a private bank and two HFCs were “managing” the quality of many loan assets with innovative accounting and liberal dose of “top-up” loans but when NHB and RBI finally decided to put up a joint drive to check their books, it was too late. 

Finally, less than 100 NHB employees are tasked with the inspection of the Rs 6 trillion assets of HFCs. We don’t need a separate mortgage regulator. Let NHB be merged with the RBI to help the banking regulator set up a new wing to regulate the HFCs.

Fine-tune the insolvency code: The Indian insolvency law is more aggressive than what most developed markets have. In the past couple of years, following the new law, the body language of both the bankers and corporate honchos has changed. The promoters are not taking their empire for granted anymore and the banks are no longer giving them kid-glove treatment. 

But on ground, things are hardly moving. Woefully inadequate infrastructure is just one of the many reasons why an insolvency case is not settled within 180 days and even 270 days as envisaged by the law. The National Company Law Tribunal and the National Company Law Appellate Tribunal have been entertaining frivolous cases as the promoters are not willing to give up their empire. If this trend continues, the insolvency law will turn into a joke. We need to find ways to stop entertaining these appeals to delay the process and frustrate the prospective buyers of bad assets and hurt banks’ books.

Set up a fiscal monitoring council:  It is worth revisiting the proposal of the committee on the Fiscal Responsibility and Budget Management for setting up a fiscal council to monitor the government’s fiscal announcements for any given year and providing its forecasts and analysis.

In the US, since 1975, the Congressional Budget Office has been producing independent analyses of budgetary and economic issues to support the Congressional budget process. It is non-partisan; conducts objective, impartial analysis; and hires its employees solely on the basis of professional competence without regard to political affiliation. It doesn’t make policy recommendations but each of its report and cost estimate summarises the methodology underlying the analysis. 

An independent council is needed as the fiscal deficit figures and the quantum of government borrowings in isolation do not tell the full story. Beyond the official market borrowing to bridge the estimated fiscal deficit, the government agencies such as Nabard, Food Corporation of India, Power Finance Corporation, Rural Electrification Corporation Ltd, National Highways Authority of India, among others, have been continuously borrowing money, with the government backing. Such quasi-sovereign borrowing runs into trillions of rupees. Then, the RBI has been paying interim dividends to the government in past two years. We need something on the lines of the International Monetary Fund’s fiscal monitor database for transparency.

Finally, RBI’s freedom: The proceedings of the past few board meetings of the RBI, before Shaktikanta Das took over as governor, were not the best illustration of how a central bank should run. With freedom, comes responsibility and the RBI brass must be held accountable to the board. Do all the directors have the expertise in central banking? Should there be directors who can have conflict of interests when it comes to issues such as liquidity and interest rates as they run their own business houses? Should the government have two nominees on the board?

The US Federal Reserve has a two-tier structure — a central authority called the Board of Governors in Washington, DC, and a decentralised network of 12 Federal Reserve Banks across the country. The seven-member board of governors of the US Fed is an independent government agency charged with overseeing the Federal Reserve system. The members, appointed by the US president and confirmed by the senate, serve staggered 14-year terms. Such a long-term is to shield them from political pressures. A board-managed RBI is a great idea, provided we have the whole-time directors with the right calibre. Let’s do that.

The columnist, a consulting editor of Business Standard, is an author and senior adviser to Jana Small Finance Bank Ltd. His latest book, HDFC Bank 2.0: From Dawn to Digital will be released in July. Twitter: @TamalBandyo