Budget and banking reforms

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A two-pronged approach that allows for greater participation of domestic private players on the one hand and recapitalisation of PSU banks on the other, is on the cards. However, issues of managerial reform also need to be addressed, says K. KANAGASABAPATHY.

The Budget 2010-11 is driven by the challenge to quickly revert to the high GDP growth path of 9 per cent. The support of the banking system is no doubt a prerequisite to achieve this goal. Realising this, the Finance Minister has announced a two-pronged strategy to strengthen the banking system.

The first is the decision to grant additional banking licences to private sector players. This would help diversify ownership and thereby increase competition. The second is a parallel provision for recapitalisation of public sector banks (PSBs) to the tune of Rs.16,500 crore. A major part of this funding is expected to be met out of a World Bank loan.


Opening the banking system to more private players is broadly consistent with the current policy stance. But the move appears rather bold and counter-intuitive in the current global environment, where many private banks are practically being acquired by the government.

When the World Bank loan proposal came to public knowledge sometime last year, there was speculation on whether the loan would carry any rider for foreign players' entry. In view of the political opposition to the entry of foreign banks, access to domestic private players is the more comfortable option at this stage.

The growing pressures of competition have already led to a gradual decline in the share of public sector banks in total commercial bank assets, at the rate of about one percentage point per annum in the last decade.

This tendency may intensify and the dominance of PSBs may eventually diminish. The government should take adequate care to maintain a level playing field between players by emphasising the social responsibility of the private sector players. The new guidelines from the Reserve Bank are expected to address this issue.

The parallel move to strengthen public sector banks is timely. While the government wants to retain its majority shareholding, fiscal constraints do not allow it to cater to the felt need of public sector banks to expand their credit and investment operations.


It is unfortunate that capital infusion into public sector banks has thus far been only to make their operations viable under Basel standards. It has never aimed at supporting the growth of their operations.

The Rakesh Mohan Committee on financial sector assessment has estimated the amount of capital contribution required from the government, on the assumptions of 20 per cent, 25 per cent and 30 per cent growth in risk weighted assets (RWA) of nationalised banks. At 25 per cent growth in RWA beginning 2007, the capital requirement for 15 banks was estimated at Rs.16,300 crore by 2012-13. The requirement of capital would increase more than proportionately if the RWA growth is higher. For instance, if the RWA increases at the rate of 30 per cent per annum, the capital requirement would increase to around Rs.50,000 crore for 19 banks. The Committee, therefore, recommended selective dilution of government ownership to below 51 per cent on a case by case basis. This option of selective dilution should be pursued by the government, if the general dilution to 33 per cent is not politically acceptable.

There are some operational issues relating to PSBs that require attention.


The first is consolidation. So far, restructuring has not led to an extensive consolidation process. The Finance Minister is reported to have said that at this juncture the issue of consolidation is not in his mind. The point was raised in both the Narasimham Committee Reports.

Both had pointed to the need for a four-tier banking sector structure. This would comprise three to four banks with global presence at the top end of the tier, followed by national banks with countrywide presence and, local and rural banks with niche markets at the lowest two tiers.

The government should, sooner than later, take a considered view on consolidation so that the prevailing uncertainty is cleared.

The second issue relates to the governance structure of PSBs. The Narasimham Committee on banking reforms (1998) had observed that it should be left to bank boards to take decisions on corporate strategy and all aspects of business management.

In the Indian case, given predominant government ownership, there has been a blurring of distinction between ownership responsibility and managerial duties.

Composition, independence and professionalism of the boards of the PSBs also remain a matter of concern.

While guidelines stipulated for bank boards need to be followed in both letter and spirit, the government should also gradually accord operational independence to bank boards. Improving flexibility of decision-making in bank management, unhindered by government interference, will remain a key challenge.

(This article was published in the Business Line print edition dated March 5, 2010)
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