Time for another VRS

Thirteen of the 27 public sector banks, which account for three-fourths of the Indian banking industry, have brought down the level of their net non-performing assets (NPA) to less than 1 per cent of net advances in the first quarter of 2006-07. Even the Chennai-based Indian Bank, which has the dubious distinction of posting the highest ever loss by any Indian bank exactly a decade ago, and had its net worth eroded, now boasts of an NPA level of just 0.57 per cent. No news can be better than this for the banking industry. The drop in the net NPA level will bring down the cost of credit as these banks can now provide less for sticky loans in their balance sheets. Provisions and write-offs account for about half a per cent of their total assets, and will go down further with the steady decline in the quantum of stressed assets. However, this alone cannot bring down the cost of credit for borrowers, as the public sector banks are plagued with other structural problems that affect their efficiency and erode their pricing power. Very high operating expenses, including the wage bill for a bloated work force, dominate the map and should be addressed with urgency.

Despite enjoying a high net interest margin (NIM) of over 3 per cent, the public sector banks have not been able to earn a proper return on assets (RoA) because of the high operating expenses, which are as much as 36 per cent of total expenses. For at least two of the State Bank of India's associate banks, they are in fact over 40 per cent of total expenses, as they are for Punjab & Sind Bank. When it comes to Punjab National Bank, Bank of Baroda and two other public sector banks, the figure is over 38 per cent. And the bulk of the operating expenses is on account of the wage bill, which accounts for over one-fourth of total expenses and close to four-fifths of operating expenses. The average wage bill of the public sector banking industry is 1.40 per cent of its total assets. For at least 10 public sector banks, including some of the large banks like the State Bank of India, Punjab National Bank and Canara Bank, the salary bill as a percentage of total assets is much higher than the industry average. No wonder then that, despite a high NIM, not too many public sector banks can register more than 1 per cent return on assets (RoA). In 2006, only nine of the 27 public sector banks had RoA of over 1 per cent. Among the large banks, the State Bank of India, Bank of India and Bank of Baroda had less than 1 per cent.

It should be clear from all this that the best way of paring the cost of loans, which the finance ministry has been stressing, is to prune the operating expenses of the public sector banking industry by cutting the flab. The industry slashed about 11 per cent of its total work force through a voluntary retirement scheme a few years ago. Since then, rapid computerisation has taken place and most banks are in a position to operate with fewer employees. The government should encourage the public sector banks to float another VRS and thereby reduce the wage bill. Till this happens, banks must redeploy their stuff to market insurance policies, mutual fund units and other financial products so as to earn a higher fee income and thus supplement their interest income.