Grooming PSBs

| Updated on February 23, 2021

The Centre needs to tone up governance of public sector banks, before privatising them

The Budget announcement on the proposed privatisation of two public sector banks has drawn polarised reactions. Bidding up the Nifty PSU Bank index by over 30 per cent since the Budget, the stock market seems to believe that privatisation is a magic pill to address performance woes at PSBs (public sector banks). The All India Bank Employees’ Union, pointing to recent failures at YES Bank and Lakshmi Vilas Bank, disputes the notion that privatisation can make any difference to PSB efficiency. As always, the truth lies somewhere in between and it is good that the Centre has reiterated its intent of not hurrying through the process and strengthening PSBs before ceding control.

Apart from legislative changes to the bank nationalisation law, the Centre may need to prepare the ground for PSB privatisation on three fronts. One, while the NDA regime seems to have distanced itself from political interference in lending, PSBs continue to be hobbled by weak risk management and appraisal systems that contribute to poor asset quality and outright fraud. RBI’s Financial Stability Report expects PSBs to end up with the lion’s share of defaults from Covid and has noted that PSBs made up 80 per cent of bank frauds by value as they doubled in FY20. Aligning top management compensation structures to markets and ushering in performance-linked pay for rank and file can help PSBs build better credit appraisal skills. For accountability, rather than relying on the draconian vigilance mechanism, PSBs need to transition to strong internal compliance and whistle-blower functions and truly independent Boards. Two, to remove market perception that critical decisions at PSBs are driven more by their promoter’s whims than sound commercial logic, the Centre needs to distance itself from strategic decisions, operations and appointments at PSBs. The merger decisions made last year show that the Banks Board Bureau, which was supposed to take over these functions, is not really in the scene. Three, to ensure that PSBs find adequate financial resources to invest in digital transformation and participate in the next upcycle, they need to be freed of their legacy bad loans and gratuitous social obligations. The Centre’s idea of setting up distinct Development Financial Institutions to free banks of project lending and set up an Asset Reconstruction entity to acquire their bad loans are sound ones. But it also needs to stop co-opting PSBs into pet schemes on financial inclusion and MSME lending.

For private investors to evince interest, the RBI will also need to do away with the regulatory grey areas currently surrounding the ideal holding structure, the advisability of allowing industrial houses and promoter skin in the game, for private banks. An RBI Internal Working Group has already submitted its recommendations on these issues, which need to be acted on without further ado.

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Published on February 23, 2021
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