Mumbai: A Reserve Bank of India (RBI) panel set up to review governance of bank boards has suggested that the government should either privatize or merge state-run banks, or design a new governance structure for these banks to allow them to compete better and avoid repeated requests for recapitalization.
The panel suggested privatization or a different governance structure in view of the low productivity and steep erosion in asset quality and “demonstrated uncompetitiveness of public sector banks over varying time periods”.
The panel, headed by former Axis Bank Ltd chairman and Morgan Stanley India head P.J. Nayak, has also suggested significant changes in the shareholding pattern of banks.
The panel suggested that the RBI should designate a specific category of investors in banks known as authorized bank investors (ABI), who would be allowed to hold as much as 20% in banks without regulatory approval. Such investors would include funds with diversified investors.
“ABIs would therefore include pension funds, provident funds, long-only mutual funds, long-short hedge funds, exchange-traded funds and private equity funds (including sovereign wealth funds) provided they are diversified, discretionally managed and found to be ‘fit and proper’,” the panel said, adding that the investor would be allowed to hold 20% provided that it does not possess the right to appoint a board director.
An ABI with a board representation should get 15% investment limit without regulatory approval. “Every other investor should be permitted no more than 10% without regulatory approval,” the panel said.
Currently, a single investor is allowed to hold only 5% stake in a bank without regulatory approval.
“This is a large judgmental issue on letting a group of investors, with significant stake, be made fit-and proper after having the stake and not before it. This can never happen,” said Diwanji, referring to the committee’s suggestion that the fit-and-proper status of an investor need not be judged prior to investment.
The Nayak panel also recommends that if a bank is identified as “distressed”, private equity and sovereign wealth funds should be permitted to take a controlling stake of up to 40%.
Nayak panel’s recommendations come against the backdrop of rising bad loans in the banking sector, particularly on the books of state-controlled banks.
Till December, 40 listed Indian banks have gross non-performing assets (NPAs) of Rs.2.43 trillion, up 36%, from previous year. Of this, about Rs.2.19 trillion are with state-run banks. Besides the bad loans, an estimated Rs.5-6 trillion loans are being restructured in the banking system. Under existing norms, banks need to set aside up to 100% of the loan value if a loan turns fully bad and 5% of the loan value if restructured.
Rising bad loans have meant that banks need more capital to set aside as provisions, in addition to the higher capital requirements under advanced basel-III norms. According to RBI estimates, Indian banking system would require Rs.8 trillion of capital to sustain a loan growth of 20%. The government is struggling to meet these capital requirement for state-owned banks, in which it is the majority owner.
In the case of public sector banks, the RBI committee suggests that a bank investment company (BIC) be set up to hold equity stakes in banks which are presently held by government.
The autonomy of BIC should be ensured and the CEO of BIC should be a professional banker, the committee said, adding that the government should stop giving any regulatory instructions to banks applicable only to PSU banks as dual instructions are discriminatory.
The government should also consider reducing its holding in banks to less than 50% to enable a level-playing field for public sector banks in matters of vigilance enforcement, employee compensation and the applicability of the right to information.
“If such incentivisation requires the government to hold less than 50% of equity in BIC, the government should consider doing so, as it will be the prime financial beneficiary of BIC’s success,” the panel said.
Privatization will improve the governance standards in banks, said Shinjini Kumar, director (banking regulations) at audit firm PricewaterhouseCoopers Pvt. Ltd.
“The current deterioration in the operations and asset quality of public sector banks would mean that the government is constantly feeding the PSBs but not getting the returns. If you have shareholders with significant stake involved at the board level, this can help to improve the governance standards of banks,” Kumar said.
However, some of these suggestions may be difficult to implement.
“The government will never let its stake go down below 50%. Besides, there are various stakeholders like unions, employees etc. These recommendations will never be acceptable,” said Diwanji.
According to the RBI panel, constraints like dual regulation of public sector banks— by the finance ministry and RBI, short appointment tenure of the leadership in banks, low compensation, vigilance enforcement and applicability of the Right to Information Act, should be rapidly eliminated or significantly reduced in order to avoid erosion of competitiveness of state owned banks.
In addition the committee recommended a minimum five-year tenure for bank chairmen and a minimum three year tenure for executive directors.
Separately, the RBI panel proposed that the ownership ceiling for promoter investors be raised to 25%. Presently the promoters are required to bring down their stake over time to a maximum of 5%. The panel added that it is not for the RBI to stipulate a time limit for a new bank to list in bourses “as premature listing could be injurious to minority shareholder interests”.
The RBI should also raise the voting rights limit to 26% in banks to align it with Companies Act, the committee suggests.