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Pranab Babu, we need financial sector reforms

Pranab Babu, we need financial sector reforms
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First Published: Sun, Jul 05 2009. 08 59 PM IST

Updated: Sun, Jul 05 2009. 08 59 PM IST
The Sensex, the Bombay Stock Exchange’s (BSE) benchmark index, has risen some 20% in the past seven weeks since the Congress-led United Progressive Alliance (UPA) won the general election. The BSE Bankex, an index for the banking industry, has risen far higher, close to 33%, during this time.
The banking industry’s expectations from Pranab Mukherjee’s budget are pretty high. Indeed, bank stocks are a proxy for the broader economy and investors tend to bet on banks when the outlook for growth is bright as expansion of credit is essential to support growth and this means higher income for banks. But this time around, many believe that Mukherjee, who has returned to North Block on Raisina Hill after 25 years, will give a big push to financial sector reforms.
The Economic Survey, presented ahead of the Union budget, has strengthened the belief. Among other things, the survey has made a strong pitch for developing the corporate debt market, encouraging trade in derivatives, aligning voting rights in banks with equity holdings, lowering the government’s stake in public sector banks, increasing the foreign direct investment (FDI) limit in Indian banks and allowing greater play to foreign banks.
Will Pranab babu actually go for big-bang financial sector reforms? Ideally, he should. The first four years of the five-year tenure of the previous UPA government was marked by high economic growth, but it was driven by global liquidity and the government could not claim any credit for that. Now, when a large part of the world is in recession, unless the finance minister pushes reforms, India will not be able to return to the high growth path. Since 2000, successive budgets have made many promises, but virtually none of them has been kept. Here are a few examples:
Paring the government’s stake in public sector banks: This is one issue the government has been struggling to address for the past nine years. Under current norms, the government’s stake in public sector banks cannot fall below 51%. In 2000, Yashwant Sinha, then finance minister of the Bharatiya Janata Party-led National Democratic Alliance government, first announced the intention to lower the government’s holding in public sector banks to 33%. The logic behind this is fairly simple—public sector banks should be owned by the government, the Indian public and foreign entities in equal proportion. So, along with paring the government stake to 33%, the foreign ownership limit should be raised from the current level of 20% to 33%. Even though government ownership is perceived to be a great strength for the banking sector globally, considering the fact that our government does not have funds to continuously infuse capital in public sector banks, it should chart out a road map for paring its stake before it’s too late.
Raising the limit of FDI in banks: Currently, the foreign ownership limit in public sector banks is capped at 20%. For private banks, it’s 74%. Within this overall limit, there is a sectoral cap for FDI and portfolio investment, at 49% each. There seems to be no logic in sticking to the 20% cap on foreign ownership in public sector banks as under corporate law, an investor needs at least a 26% stake to play a meaningful role in running a company. Moreover, investors who buy stakes via the portfolio route do not have voting rights. So lifting the foreign ownership limit in public sector banks to at least 25%, to start with, will not make any radical change in the ownership policy but demonstrate the government’s intention to move ahead on the reform path. In the next phase, it can be raised to 33%.
Lifting the cap on voting rights: This is yet another long-pending issue that successive finance ministers promised to resolve but could not. In private banks, voting rights are capped at 10% and in public sector banks at 1%. The banking regulator too is not very comfortable with the idea because it feels that even though one entity cannot hold more than 5% of a bank, there could be occasions when an overseas group will end up wielding more power by holding stakes through different group firms. A case in point is Temasek Holdings Pvt. Ltd and Government of Singapore Investment Corp. Pte Ltd, Singapore’s state-owned investment firms. They can hunt as a pair and between them enjoy higher voting rights. But there are ways to introduce checks and balances to prevent any misuse of voting rights and worrying too much over such issues will never allow the government to open up any sector.
To lift the cap on voting rights, the government needs to amend a banking law. The amendment will also pave the path for private banks to issue preference shares. Once they are allowed to do so, they will be able to shore up capital and meet credit demand from companies when it picks up.
Allowing foreign banks greater play: In 2005, the banking regulator charted a road map for foreign banks in India. In the first phase, it allowed them to convert their branches into wholly owned subsidiaries. The next phase was to begin in 2009. The global financial crisis in 2008 that saw the collapse of a few banks and government bailouts of many will delay the process, but nothing can prevent Pranab babu from relaying the road map. Along with larger play for foreign banks, the government can also take a relook at the old proposal of allowing big and reputed domestic industrial groups to float commercial banks. This will intensify competition and benefit consumers.
Tamal Bandyopadhyay keeps a close eye on all things banking from his perch as Mint’s deputy managing editor in Mumbai. Please email comments to bankerstrust@livemint.com
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First Published: Sun, Jul 05 2009. 08 59 PM IST