Tamal Bandyopadhyay: A freedom movement for banks

There is wide scope for the government to grant state-run banks greater autonomy

The United Progressive Alliance's Common Minimum Programme (CMP) made two important commitments: cheap credit to the agriculture sector and freedom to public sector banks to manage their business.

At first glance, the two promises contradict each other since the government cannot offer public sector banks managerial freedom and, at the same time, force them to lend cheaply to the farm sector.

In reality both are possible, if only because banks are eager to lend to the agriculture sector because it can be a profitable business. Some Indian commercial banks have already been working hard at ramping up their loans to farmers and small-scale entrepreneurs now that big corporations prefer turning to the markets to raise money.

Currently, both public- and private-sector banks need to fulfil a priority sector lending target of 40 per cent of net bank credit.

For foreign banks, the obligation is 32 per cent. Within the overall 40 per cent target, local banks have a sub-target of 18 per cent for agriculture and 10 per cent to weaker sections of society, but there is no sub-target for lending to the small scale sector.

Foreign players, on the other hand, have no sub-target for agricultural loans and advances to weaker sections but they must lend 10 per cent to small-scale borrowers and 12 per cent to exporters. Export credit, however, does not come under the priority sector ambit for domestic banks.

According to the Tenth Plan projections, the flow of credit to agriculture and allied activities is expected to be Rs 7,36,570 crore.

However, despite the extensive outreach of rural and semi-urban branches of commercial banks (about 33,000), cooperative banks (about 1 lakh) and regional rural banks (about 14,000), the estimated actual flow of credit to agriculture from formal rural financial institutions during the first year of the Tenth Five Year Plan "" 2002-03 "" stood at Rs 69,560 crore against the projected Rs 82,073 crore. So there is no denying that there is a need to double credit flows to agriculture.

One also needs to remember that the 18 per cent target for agricultural lending was fixed at a time when the reserve requirements were as high as 63 per cent. Since reserve requirements have been drastically reduced over the years, banks' total lendable resources have increased dramatically.

Banks normally extend two types of credit to this sector "" short-term credit for seasonal operations and long-term credit for creation of assets.

The growth rate of aggregate short-term credit has been stagnant at about 14 per cent over the past three decades while long-term credit has declined from 20 per cent in the 1970s to about 12 per cent in the 1990s. The sharp decline in the growth of investment credit has dented agricultural borrowers' credit absorption capacity.

Banks have traditionally had reservations about lending to these sectors because the default rates under various government programmes are high. Transaction costs are also high because the amount of loans are small. Finally, the character of the small-scale segment has changed dramatically following liberalisation.

This means that the banks need to evolve a new financing model. Some banks have started doing so by indirectly involving big industrial houses. They are financing contract farming where corporations are buying the produce and taking responsibility for repaying the bank loans.

In effect, although the loans are disbursed to individuals, they are backed by big companies in case of a default.

The Securitisation and Asset Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002 (Sarfaesi Act) "" which has given bankers the handle to tackle rogue borrowers by seizing and selling their assets "" does not allow banks to take possession of agricultural land for recovery of bank loans.

So the banks will need the state governments' support to collect their dues. Computerisation of land records (as Karnataka has done) and recognition of the rights of the tenant farmers and sharecroppers can also create the right environment for the banks to take the long march to rural India.

As we have seen, there is a convergence of interests between the CMP and state-run banks as far as agricultural lending is concerned. But will the government really grant state-owned banks full freedom? And what does this promise really entail?

First, let's take a look at public sector bank managements. They are board-driven and the government is their majority owner. The credit for the robustness of the Indian banking system goes to the government because it always steps in to avert a systemic crisis. Since the 1990s, the government has pumped in over Rs 22,000 crore worth of recapitalisation funds to nurse public sector banks back to health.

Thus, when it comes to ownership, the government gets full marks. As a manager, it's an abject failure. Take, for instance, the case of "independent" directors on the bank boards who are selected by the government in consultation with the Reserve Bank of India (RBI).

Some of them are neither "independent" nor competent enough to make any meaningful contribution to the board proceedings. Even those corporate chiefs who have been accused of insider tradings often find berths on board of large banks and financial institutions.

The process of giving managerial freedom should start from the level of appointing board directors and even the chairman of the public sector banks.

The government has dismantled the Banking Service Recruitment Board for recruitment of employees, but the chairman is still appointed by the government on the recommendations of the appointments board headed by the RBI governor. But this board does not have the last word on the chairman's appointment "" that's often the prerogative of politicians.

Another contentious issue is the tenure of a bank chairman. Unless the chairman gets a reasonably long tenure, he will not be able to function effectively. In the private sector, HDFC Bank's chief Aditya Puri has been at the helm of affairs for over eight years now. ICICI Bank identifies the leader well in advance and grooms the person for the top job as an understudy of the incumbent.

In contrast, the average tenure of a public sector bank chief is about two to three years. This is not enough to even understand a big organisation if the candidate is an outsider.

The take-off point for addressing managerial freedom in the state-run banking sector could be the revision of CEO pay packets and the introduction of incentives.

The CEO of a weak bank will certainly feel more enthusiastic about turning around the institution if there were a suitable monetary incentive at the end of the long haul. The CEO of a listed bank should also get a share of the profit if his bank does well.

Those who think this unfair should take a look at the pay packets of public sector bankers. The chairman of State Bank of India, who manages a balance sheet of over Rs 4,00,000 crore, gets a monthly salary of around Rs 40,000. His counterpart in the private sector ICICI Bank, which has a balance sheet size of over Rs 1,25,000 crore, gets many time more.

In foreign banks, the entry-level salary of professionally qualified employees is often more than what a chairman of a public sector bank gets after three decades in the profession.

Public sector banks should also be given the freedom to recruit from the market at various levels. So far, they are allowed to recruit directly for select business pockets like infotech. Some banks try to circumvent the rule by being innovative.

For instance, a large public sector bank goes to a B-school for campus recruitment for its merchant banking outfit. Once they are hired, the new recruits are deployed in the bank on deputation. This is done because otherwise the bank is not in a position to pay these recruits market-level salaries when its employees are earning a pittance.

Finally, it's time a take a relook at the Central Vigilance Commission. Whether it is an appointment of a consultant or IT vendor, this government watchdog breathes down the banks' neck to make them follow the L1 (that is, the lowest quote) formula.

So the banks tend to forget about quality of work. It's easier for a retired bank executive than an established firm to get a consultancy assignment because the executive's services come cheap.

Similarly, a lesser-known hardware vendor can get the contract for setting up the IT network, beating more worthy competition.