Have Recent Reforms in Banking Sector Achieved The Desired Results?

First published on: 2019-12-06 Socio-Economic Development

Amalgamation of ten public sector banks into 4 major banks is one of the big banking sector reforms started by the Government in 2019

According to a recent RBI report, there are three major problems in the Indian banking system. These are bad loans, cyber threats and bank fraud. While cyber threats, and bank fraud can be solved using stricter security mechanisms, rising NPAs or bad loans are the real challenge facing the banking industry today.

Bad Debts

India's bad debts of about Rs 10 lakh crore are larger than the GDP of at least 137 countries. But so far, the RBI's efforts to reduce non-performing assets (NPAs) in the banking sector have yielded very few results.

In 2017, the central government formed an alternative mechanisms panel under former finance minister Arun Jaitley to oversee merger proposals of public sector banks. Other members included Piyush Goyal and Nirmala Sitharaman. Prior to this decision, the government had announced a Rs 2.11 trillion bank recapitalization scheme for public sector banks suffering from bad loans.

The objective of creating large banks through strengthening PSBs is to meet the credit needs of the growing Indian economy. It also aims to build capacity to raise resources without dependence on the public exchequer. Banking units formed after the merger of PSU banks will be able to absorb shocks.

The latest budget has indicated a determination to strengthen the banking and financial sector. As a result, many major changes are taking place in the banking and financial sector.

Points To Remember

    • There are three major problems in the Indian banking system
    • Large PSBs are expected to meet the credit needs of the growing Indian economy
    • The four mega mergers of public sector banks (PSBs aim to form a stepping stone to the government's $ 5 trillion GDP target.

Merger and Capital Infusion as a Solution

The major steps taken this year are the amalgamation of ten public sector banks into 4 major banks. We now have a total of 12 public sector banks. In 2017 there were 27 banks. In addition, the government has announced a capital upfront capital infusion of Rs 55250 crore in public sector banks. PNB to get Rs 16,000 crore; 11,700 crore to Union Bank; 6,500 crore to Canara Bank; Rs 3,800 crore to Indian Overseas Bank; 3,300 crore to Central Bank of India; 7,000 crores to Bank of Baroda; Rs 2,500 crore to Indian Bank and Rs 2,100 crore to UCO Bank.

Large bank mergers include (i) Punjab National Bank, Oriental Bank of Commerce and United Bank (ii) Canara Bank and Syndicate Bank (iii) Union Bank of India, Andhra Bank and Corporation Bank, and (iv) Indian Bank and Allahabad Bank. Merger is included.

The four mega mergers of public sector banks (PSBs), which control a third of India's banking in terms of advances and deposits, aim to form a stepping stone to the government's $ 5 trillion GDP target.

Benefits of Consolidation

The Center has listed three broad benefits from the current consolidation practice: increasing lending capacity, stronger national presence and global reach and operational efficiency gains to reduce lending costs. But goals can be elusive. Size alone will not guarantee better results. The largest, SBI, is a classic example of this.

Reform of the Board of Public Sector Banks

The next reform associated with the current set of reforms is the reform of boards of public sector banks. This reform, however, has not gone too far as it failed to relinquish control over top management appointments considered to be the keys to the efficient functioning of banks. Boards of banks can now evaluate the performance of senior management from general manager to managing director.

Under current practice, general managers are evaluated by executive directors, who are evaluated by MDs. But there is no formal evaluation process for MDs. At the end of every financial year, the MD signs a memorandum of understanding (MoU) with the government. After a full year, MoU points are scored, and an MD bonus is issued by the board based on the points. Now the government proposes that the board can directly appoint an MD. However, experts say that evaluating general managers will not be easy as the board does not have sufficient knowledge to know all the functioning of the banks that they handle.

It will be ED and MD who will approve GM. The Center also gave freedom to the banks to appoint the Chief General Manager as and when required.

In the opinion of some experts, the mandate to appoint top management should be given to an independent institution free from government influence. Otherwise, the appointed officials will shy away from making independent decisions. It is clear that the government is still hesitant to give total control to the Bank Board Bureau.

More importantly, the finance minister said that banks can recruit Chief Risk Officers (CROs) from the market, "on compensation associated with the market to attract the best talent". According to experts, it can be a game changer if the officer is given enough rights to call on loan decisions. The Risk Management Committee will be mandated to fix accountability for compliance with the Risk Appetite Framework.

To enable succession planning, bank boards can decide the system of 'personal development schemes' for all senior executive positions. To ensure adequate tenure, boards are now given the flexibility to preserve two years of residual service for the appointment of GM and above. A large number of PSBs can now increase the seating fees of non-government directors (NODs), which will also be evaluated annually by the Nod board.

It remains to be seen, however, how effective these reforms are going to be. Till then we can only keep our fingers crossed.

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Tags: Banking Sector Reforms, bad debts, consolidation of banks, Public Sector Banking, Merger and acquisitions in banking, amalgamation of PSBs, alternative mechanisms panel