Tamal Bandyopadhyay: Masters of managerial autonomy

How the finance ministry acts as the super-board for public sector banks

Over the past one month, Finance Minister P Chidambaram has iterated with conviction the government's move to allow 74 per cent foreign direct investment (FDI) in the country's banking sector.

At various fora "" ranging from the floor of Parliament to the World Economic Forum meet in Delhi "" Chidambaram has assured global investors that the government is committed to opening up the sector.

He has even suggested that foreign banks will be allowed to take a stake of up to 10 per cent a year in local private banks and gradually increase it over the years.

The provocation for Chidambaram's repeated statements on FDI in the private bank space could be the Reserve Bank of India's (RBI's) insistence on restricting foreign banks' entry in the segment.

Otherwise, why would the finance minister talk about opening up the sector, while the government had already notified raising FDI in private sector banks to 74 per cent through the automatic route on January 15?

A press note issued by the department of industrial policy and promotion of the ministry of commerce and industry (on March 5, 2004), states, quoting the notification: "The aggregate foreign investment in a private bank from all sources will be allowed a maximum of 74 per cent of the paid up capital of the bank. At all times, at least 26 per cent of the paid up capital will be held by residents, except in regard to a wholly-owned subsidiary of a foreign bank."

The genesis of the confusion was the RBI's draft guidelines on ownership in private banks released in July. The guidelines clearly said no single entity "" unless it is widely held "" should be allowed to hold more than 10 per cent stake in a private bank.

It also capped the stake of a foreign bank "" that is operating in India "" in a private bank at 5 per cent. Subsequently, in September, there was a panel discussion on this issue where all interested parties "" foreign and private banks, private equity funds and RBI executives "" participated; however, the promised second draft of the guidelines has not yet been released.

The RBI as well as the finance ministry are known to play on people's patience. For instance, the RBI took more than six months to decide the fate of HSBC's acquisition of the UTI Bank stake.

The ministry, on its part, has taken years but still has not been able to decide on lifting the 10 per cent cap on voting rights in private banks.

Both the regulator and the ministry are believed to have been engaged in a long dialogue on the twin issues of ownership and voting rights in private banking. No wonder there is no time to clear the public issue of Punjab National Bank (PNB).

PNB and many other public sector banks want to tap the capital market. The idea is to dilute the government's stake and raise capital from the public to support their asset growth. If they can hit the market now, they will be able to collect a handsome premium on par value of their shares.

But the government has some other plans. It wants to sell part of its stake in PNB to make some money. There is nothing wrong in it, but the hitch is, unlike other public sector undertakings like the National Thermal Power Corporation or the Oil and Natural Gas Corporation, in a bank, the government cannot sell its stake to the public.

The Banking Regulation Act allows the government to dilute its stake only through issuance of fresh equity shares by banks. So the law ministry put a spoke in the finance ministry's proposal.

An undeterred finance ministry has now sought the opinion of the Attorney General on the issue. It doesn't matter to the ministry that PNB is losing precious time and it may not be able to get the best price when it is finally allowed to enter the market.

Soon Oriental Bank of Commerce and Bank of Baroda, too, will face the same situation. Like PNB, their scrips, too, have been doing well on the bourses and it's only natural that the government will be tempted to encash part of its stake in these banks, too.

The government should have thought this well in advance and amended the Banking Regulation Act or sought a Parliamentary approval for selling its stake to the public. After all, making money on its capital investment in banks is not entirely a new idea for the government.

Last year, when some of the banks wanted to return government capital at par, the government demanded a premium on its capital investment.

Once the norms are in place, the government can divest its stake in any public sector bank as and when it wants to. It does not necessarily have to be linked to a bank's capital raising plan.

The bigger question is: why would a bank need the finance ministry's approval for tapping the market when the norms have been clearly laid down?

The law does not allow public sector banks to reduce the government's stake below 51 per cent. So, if a bank wants to have a public issue without disturbing procedures and gets board approval, why would it need to knock at the doors of the finance ministry for its nod? The PNB board approved the public issue on September 13. The government has not been able to clear it in three-and-a-half months.

This makes it clear that the PSU banks are not necessarily board-driven. There is a super-board called the finance ministry.

No wonder that the report of an advisory group in the RBI on corporate governance (Standing Committee on International Financial Standards and Codes) has said that corporate governance in public sector banks is complicated by the fact that effective management of these banks vests with the government and the top managements and the boards of banks operate merely as functionaries.

The government, the report says, performs simultaneously, multiple functions "" that of the owner, manager, quasi-regulator and sometimes also the super-regulator.

Consider some of these facts:

The nominees of the RBI and the government are superior to other directors. The annual general meeting (AGM) of a public sector bank cannot be conducted without the presence of the government nominee even if there is a quorum.

There are certain committees of the public sector bank boards that cannot function unless the directors appointed by the RBI and government participate.

The rights of private shareholders of State Bank of India and other public sector banks are limited because their approval is not required for paying dividend or adopting annual accounts. The AGMs merely take note of accounts of dividend payment but not approve them "" a task done by the board.

All these rules are likely to continue even if the government decides to dilute its holdings to below 51 per cent because the finance ministry has made it clear that the public sector character of these banks will remain unchanged even after it ceases to have majority ownership.

If you are a majority shareholder or a promoter of a bank in Belgium, while registering with the Banking Commission you are required to sign a protocol of managerial autonomy.

You need to commit that you will not, in any way, interfere with the freedom of the management and the board of directors. In India, if any such move is contemplated by the RBI, the government will be the most hurt.