Tamal Bandyopadhyay: The mirage of autonomy

The finance ministry's decision to enforce performance targets for public sector banks through MoUs is a setback to both management autonomy as well as shareholders' interests.

Barely a month after promising autonomy to public sector banks (PSBs), the finance ministry announced that it would sign a memorandum of understanding (MoU) with each of the PSBs outlining their annual business targets.

Going by the plan, the banks would require to fix targets under various performance parameters, get the approval of their respective boards and place it before the banking division of the finance ministry by the end of this month. Once the MoU is signed, banks will have to achieve the targets.

Prima facie, this could be a logical extension of the autonomy package. The argument is: after offering them autonomy, the ministry wants to adopt a hands-off approach and stay away from micro-management of banks.

Once it signs an MoU with the banks, it would expect the financial intermediaries to achieve the targets. After all, it follows the same methodology for Navaratna companies.

However, there could be an entirely different interpretation of the move too. Even after announcing the autonomy package, the government has not been able to shed its lala psyche.

Even though it does not fully own these banks, it wants to have the last word on their performance even if that reduces the importance of the role of the board. If this is true, then PSBs have a schizophrenic owner.

First, let's take a close look at the plan. The finance ministry wants to sign an MoU with each of the 27 PSBs "" 19 nationalised banks and State Bank of India (SBI) and its seven associates.

It is, however, not known who will sign the document with the State Bank group "" the ministry or the Reserve Bank of India (RBI), which is a majority stake holder in SBI.

The focus of the MoU will be both on financial performance as well as on prudential norms. There are about a dozen parameters on which the banks will be required to set targets.

They are business (read deposits and advances) growth, return on assets, return on net worth, non-performing assets (NPAs), cost-income ratio, capital adequacy ratio, operating cost, net profit, priority sector lending and so on. Then, there are a few qualitative areas also such as risk management and implementation of Basel II norms.

In the mid-1990s, the banking sector regulator "" the RBI "" put in place a system of signing MoUs with PSBs. This was a precondition to pumping in capital in these banks, which had their capital base eroded by the huge provisions that they were forced to make to clean up their balance sheets.

The government had pumped in over Rs 20,000 crore worth of recapitalisation bonds in PSBs to shore up their capital base. The focus of the MoUs at that time was on business growth, closure and merger of unviable branches and the meeting of other prudential norms such as NPAs, capital adequacy and so on.

Trade unions were unhappy at the terms of conditions of the MoUs as an increasing number of banks committed to merge or close down unviable branches and redeploy the idle work force.

However, nobody questioned the RBI's locus standi in forcing those conditions down the throat of the banking system, which was in the throes of a crisis. Moreover, the government was the sole owner of these banks and it was only natural to set terms and conditions for recapitalising them.

Now, the situation is very different. Barring a few exceptions, by and large, the PSBs are prudent and healthy. Moreover, the government is not the sole owner of these banks.

Except for four "" Central Bank in Mumbai, United Bank of India in Kolkata, Indian Bank in Chennai and Punjab & Sind Bank in Delhi "" all PSBs have public holdings.

In Oriental Bank of Commerce and Dena Bank, the government holding has dropped to around 51 per cent following public floats. In other PSBs, the government holding varies between 53.87 per cent (Vijaya Bank) and 74.98 per cent (Uco Bank).

By unilaterally deciding to enter into MoUs with banks, the government has made it clear that it does not care about the interest of the minority shareholders.

The banks are, indeed, board-driven but there is a super-board called the banking division of the finance ministry that has the last word.

The MoU parameters also highlight the major bane of the banking industry "" setting targets. Bankers hardly bother about the quality of assets and transparency when they are haunted by the nightmare of targets.

What do they do? They offer loans to corporations in the last fortnight of a financial year to prop up the advances book. The same corporations are then wooed to keep the money (taken as loans) with the same bank in the form of deposits.

This way, the deposit portfolio of the bank also swells and it comfortably reaches the business target.

Similarly, the net NPAs of a bank drop drastically when it makes huge provisions but the gross NPAs remain static because it is unable to arrest the fresh slippages.

In other words, by merely signing the MoUs, the ministry will not be able to enthuse the banks to do better. If it wants to judge the performance of the CEOs, there are other ways to do so.

The larger issue is, however, that of corporate governance. Does the government have the right to ignore the interest of minority shareholders? The MoU with the ministry will be a sort of guidance on the banks' performance.

Based on this guidance, an investor can take a call on whether to stay invested in a particular bank or sell off its shares in the market or even buy more.

By being privy to the targets set in the MoU, only the government will have access to the guidance and other shareholders, including the foreign institutional investors (FIIs) who have been buying bank stocks aggressively, will be kept in the dark.

An advisory group in the RBI on corporate governance (Standing Committee on International Financial Standards and Codes) has said that the government performs multiple functions simultaneously "" that of the owner, manager, quasi-regulator and sometimes also the super-regulator. The proposed MoU is a testament to this.

The government can always argue that PSBs, even though listed, are not governed by the Companies Act that acknowledges minority shareholders' rights.

The governing Act for PSBs is the Banking Companies (Acquisition and Transfer of Undertakings) Act, which gives sweeping powers to the government.

For instance, the rights of private shareholders of PSBs are limited because their approval is not required for paying dividend or adopting annual accounts.

The annual general meetings merely take note of accounts of dividend payment but not approve them.

The moot question is: should the government go by the letter of corporate governance or the spirit? If it cares for the spirit of governance, then it should leave the job of running PSBs to the board and stop behaving like a schizophrenic owner.