Tamal Bandyopadhyay: Won't bank on the Budget

With the non-food credit growth galloping over the year, and their bond portfolio relatively safe now that interest rates have stabilised, commercial bankers are an excited lot these days.

More so, given the greater managerial autonomy they've got now on Tuesday, they can make acquisitions, close or merge branches and float subsidiaries without the government's approval.

But ask any one of the bankers about his expectations from the Union Budget and it's likely that his smile will disappear, replaced with a vacant look.

Given just how various Budget promises over the years haven't been honoured, this is hardly surprising.

Some glaring instances of these are the ones pertaining to raising foreign direct investment (FDI) limits to 74 per cent in private banks, lifting the 10 per cent cap on voting rights in private banks, allowing foreign banks a greater presence through the subsidiary route, and bringing down the government stake in public sector banks to 33 per cent.

Five years ago, Yashwant Sinha made a big-bang announcement of bringing down the government holding in public sector banks to 33 per cent.

It was, at the same time, made clear that the government would retain management control over the public sector banks, implying that the reduction of its stake would not tantamount to privatisation.

In 2002, Sinha announced a major concession to foreign banks operating in India by allowing them to come in through the subsidiary route.

"A foreign bank will have to choose only one of the two options (between branches and subsidiary). Such subsidiaries will have to adhere to all banking regulations, including priority sector lending norms and so on," Sinha had said.

Neither of Sinha's promises, however, translated into policy action.

There was no notification on bringing down government equity in banks, no change in the Banking Regulation Act that lays down the level to which the government can reduce its equity in PSU banks, and even after three years, the Reserve Bank of India has not been able to chalk out a roadmap for foreign banks' role on the Indian turf.

In 2003, Sinha's successor Jaswant Singh added another important promise that he could not keep. To begin with, he reiterated the promise made by Sinha on the removal of the 10 per cent cap on voting rights in private sector banks.

He then made a fresh promise to raise foreign investment limits in private banks from 49 per cent to 74 per cent. Singh said, "The voting rights of any person holding shares of a banking company are restricted to 10 per cent irrespective of his/ her shareholding. The Banking Regulation Act, 1949, will be amended to remove this limitation."

On foreign investment limits, he said: "Foreign direct investment in the banking companies in India is presently capped at 49 per cent from all sources under the automatic route. For facilitating the setting up of subsidiaries by foreign banks as well as for inviting investment in private banks, this limit will be raised to at least 74 per cent."

Though the government could not move an inch on the voting rights issue, it did actually come out with a notification on the FDI on January 15, 2004.

The notification said: "The aggregate foreign investment in a private bank from all sources will be allowed up to 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 have to be held by residents, except in regards to a wholly-owned subsidiary of a foreign bank."

When tested, however, it was found that this didn't really work either. When HSBC wanted to pick up a 20 per cent stake in UTI Bank last year, the RBI sat on the application for nine months, and HSBC was finally allowed to pick up only 14 per cent, that too with a rider that this would be reduced to 10 per cent if need be.

Chidambaram, of course, made no direct promises on banking in last year's Budget.

While he proposed to raise the FDI cap in telecom from 49 per cent to 74 per cent; from 40 to 49 per cent in civil aviation; and from 26 per cent to 49 in insurance, he hasn't been able to keep his promise on insurance.

But while there was no explicit Budget promise on banking, the government all along signalled that it was going to move ahead on the earlier promises.

The banking sector regulator, however, has reservations on these promises and the Left, which is uncomfortable with the idea of opening up the banking sector, feels the RBI should have the last word on banking.

What will Chidambaram do this time? Will he say yes to 74 per cent FDI in private banks, thus over-ruling the RBI's concerns? Can he lift the cap on voting rights? After all, without freeing the voting rights, higher FDI does not make any sense.

While he may wish to lie low on the issue, events are likely to force him to take a decision. Take the case of Dena Bank, which has recently entered the market with its second public issue, bringing down the government's stake to 51 per cent, the minimum permissible level by the Banking Regulation Act.

Since it will not be easy for the bank to generate enough profit and plough that back to its reserves, how will Dena Bank survive in the years to come? There will be three choices before the government "� recapitalise the bank, allow it to be merged with a stronger bank, or bring down the government stake below 51 per cent.

There is no other option.

Other banks like Punjab National Bank (PNB), Oriental Bank of Commerce, Allahabad Bank and Bank of Baroda, too, are ready for their second round of public offerings over the next few months. Once this happens, the government stake in these banks will fall to between 53 and 55 per cent.

If credit off-take continues to grow at a fast pace, these banks, too, may need to enter the capital market again over the next few years. But this will mean that the government bring down its stake to below 51 per cent.

While the government has chosen the non-confrontationist path in the banking sector, the PNB case offers some useful pointers.

The finance ministry cleared PNB's second public issue with an explicit understanding that post-issue, PNB would return part of the government equity to the Centre at the premium it earns from the market.

While the law does not permit the government to offload its stake in PSU banks, this has been done by getting PNB to issue fresh equity, and analysts expect the PNB issue to get around Rs 1,050 crore from the PNB deal.

This is a unique case of passive disinvestment. With such large sums of money to be got, to fulfil social sector and other obligations, the government would do well to pay serious attention to reforms in the banking sector.