Tamal Bandyopadhyay: A progressive alliance for banks?

In an unscheduled press conference a day after his surprise appointment as prime minister, Manmohan Singh ruled out privatisation of nationalised banks and strategically important oil companies like Gail India and Oil and Natural Gas Corporation (ONGC).

Predictably, the announcement hit bank stocks hard and there was widespread apprehension that the new government would derail financial sector reform.

Suddenly, every analyst started looking at the Bharatiya Janata Party (BJP)-led National Democratic Alliance (NDA) as the messiah of the financial sector.

Is this perception correct? Did the NDA government really push financial sector reforms? Will there be a void in the sector with the new government in charge?

There is no doubt that the NDA government did try to encourage consolidation in the financial sector to unlock the energy for mergers and acquisitions (M&As).

It was also instrumental in killing some of the terminally ill financial intermediaries. All these led to a distinct change in bankers' outlook; even the normally sedate public sector bankers started talking of targets for possible acquisitions.

The former government also took some hard decisions about cleaning up the mess created over decades of indifference and government interference.

For instance, it dismantled the old Unit Trust of India (UTI) and replaced it with a new, professionally-managed entity that no longer needs to protect the market on the government's behalf.

Then again, it merged the sick financial institution, Industrial Finance Corporation of India (IFCI), with Punjab National Bank and repositioned the other financial institution, the Industrial Development Bank of India (IDBI) as a bank.

The government also tried to restructure the Infrastructure Development Finance Company (IDFC) but the move was stalled following stiff resistance by the institution's management.

These are all structural issues in which the government really had little choice "" certainly it could not have allowed a UTI to fail. But what else did the NDA government do on the policy front?

First, consider the government's role in nationalised banks.

It was the Congress government that reduced the Centre's stake in public sector banks to 51 per cent through an amendment to the Banking Regulation Act, 1949. The NDA government wanted to reduce it further to 33 per cent but the Bill was never passed in Parliament because the Left and other parties opposed it.

Significantly, even when the proposal to reduce the government stake to 33 per cent was made, Yashwant Sinha, then finance minister, said that the "public sector character of the banks would not change".

So where was the question of privatising the public sector undertaking (PSU) banks?

In fact, Prime Minister Singh's approach to the PSU banks is no different from that of Sinha's when he said: "Public sector undertakings would be free to raise resources through disinvestment or sale of equity as long as they remain public enterprises but the government would not privatise profitable state-owned firms."

That the NDA government never promised to privatise PSU banks was also illustrated by the fact that the Reserve Bank of India (RBI) (in consultation with the government) did not allow Indian corporations to own more than a 10 per cent stake in a bank. Only finance professionals, non-banking finance companies and institutional promoters have been allowed to float banks, not big corporate houses.

Nor did the NDA government raise the voting rights of shareholders in private banks "" a major stumbling block for M&As in the sector. In two successive Budgets (2002 and 2003), both Sinha and Jaswant Singh announced the government's intention to remove the cap but the change never materialised.

Last year's Budget proposal raising the cap on foreign direct investment (FDI) in banks from 49 to 74 per cent also created more hype that it deserved. The government later clarified that the 74 per cent foreign stake included foreign institutional investor (FII) investment and not FDI alone. The government, in fact, has created a sub-limit for the FIIs (at 49 per cent) within the overall 74 per cent foreign holding.

The government did, however, open up the banking sector by allowing foreign players to float wholly-owned subsidiaries in India. But the final guidelines on this have not yet been circulated.

Meanwhile, the RBI proposal to disallow a foreign bank that has already been operating in India to acquire more than a 10 per cent stake in a local bank and leaving the voting right for them unchanged at 10 per cent has added to the confusion.

Does that mean the NDA government was a regime of unkept promises? Not entirely. The NDA could legitimately claim credit for creating a new interest rate architecture through successive cuts in small savings rate.

Politically, this was a hugely unpopular move because it hit the saving community hard but it worked wonders for the system. The series of cuts in administrative interest rates reduced the interest rates in general and benefited India Inc enormously, which cashed in by prepaying high-cost old debt and raising fresh, cheap debt.

The banking industry also earned huge profits on their bond portfolios. In four years between 2000 and 2004, the yield on benchmark 10-year paper has been more than halved "" from 11.70 per cent to 5.20 per cent or so.

Banks took advantage of this southward movement of rates and used the profit generated from these earnings to clean up their balance sheets by making huge provisions for their non-performing assets (NPAs).

This along with the Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest (Sarfaisi) Act 2002 fuelled the rally in bank stocks by giving banks the means to tackle rogue borrowers.

There are widespread apprehensions now that banks will be forced to increase their exposure to agriculture. These apprehensions could be misplaced; traditionally Indian banks are required to lend 40 per cent of their credit portfolio to the priority sector and 18 per cent of this is allocated to agriculture.

There has always been pressure on banks to lend to the farmers. The NDA government, in fact, forced banks to cut lending rates and offer concessional loans to coffee growers and small farmers.

Even if the new finance minister follows this norm, it is unlikely to have any impact on the business of banking because agriculture is a profitable business for banks these days.

At a time when corporations are unwilling to borrow, most banks are chasing rural customers. They have devised ways of making agricultural lending a money-making proposition by involving corporations in the game and ensuring the repayment of loans.

The only concern before the banking industry today could be the risk of systemic abuse. To be fair, this has nothing to do with the change in government.

Empirical evidence shows that governments "" irrespective of their political hue "" come to the rescue of the banking sector whenever there is a problem, nurse it back to health and exploit it again when the going is good. With low level of NPAs, high capital adequacy ratio and strong balance sheets, Indian PSU banks run this risk again.

If there is less chance of political manipulation it is because bankers are different today. They are smart enough to duck government overtures and wise enough to look after their constituencies well "" not the vote banks but the FIIs, private equity investors and millions of domestic shareholders.