As the owner and the single largest shareholder of public sector banks (PSBs), the Government is now flexing its muscles to ensure that PSBs optimally use their capital.

Setting the tone clearly, the Finance Ministry has shot off a letter to chief executives of all public sector banks, asking them to “strive hard” to achieve the targeted objectives set out in the memorandum of understanding (MoU) signed with the Central Government in 2011-12.

The banks have been asked to “pull up their socks” during the residual one-year period of MoU, as the achievements so far have been “below par”, official sources said.

The objective of the five-year MoU is to improve long-term profitability, quality of assets and optimum utilisation of capital, a scarce resource.

The Department of Financial Services (DFS) has now suggested five areas through which banks can strengthen their internal processes and generate additional capital savings in the near-to-medium term.

These areas are capital release through risk weighted assets reduction, deploying more stringent risk-based pricing, strengthening performance management, capacity building of key bank staff and review of all subsidiaries/JVs of the bank.

PSBs have been given three months to identify opportunities across these areas, design a roadmap and initiate execution, official sources said.

Progress on this front will be an important consideration into decisions on further capital infusion, the Finance Ministry has said.

This is the first time that the Finance Ministry has taken an initiative to help banks efficiently deploy their existing capital and reduce reliance on external capital infusion from shareholders, sources in the banking industry said.

Subsidiaries/JVs Banks have been asked to evaluate its optimal subsidiary. This will include a strategic assessment of what subsidiaries the can bank consider exiting or reducing its stake in, the Finance Ministry has said.

Risk-Based pricing Banks have now been advised to deploy more stringent risk-based pricing for all new origination and implementing improved scoring model to enable this. This will help increase the overall return on equity (ROE) of the portfolio and generate internal accruals needed for future capital, the DFS letter said.

“Although risk-based pricing is ideal, issues like competition and the liquidity in the system play a crucial role in deciding on such an approach”, V Kannan, Chairman and Managing Director, Vijaya Bank, told BusinessLine , when asked about risk-based pricing.

Finance Ministry has suggested banks can reduce their risk weighted assets (RWA) by 10-15 per cent by improving data quality and data clean-up for existing assets, which will tighten the processes for RWA allocation and its execution.

Most banks did a similar exercise two years ago. The same should be reviewed and implemented on a continued basis, the Finance Ministry has said.

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