Dear Mr Chidambaram,
The Indian banking community has never let you down. After the United Progressive Alliance (UPA)-led government came to power, you had exhorted the public sector banks to double their exposure to agriculture loans in three years. They have obliged you. You had also directed them to offer small farm loans at a concessional rate of 7%. The bankers never said no to it. The CEOs of public sector banks that account for close to 70% of the industry have a special affinity for you as very few Indian finance ministers in the past have understood the sector the way you do.
You played a major role in opening up the health insurance business ahead of life and general insurance sectors. You were also instrumental in setting up the Infrastructure Development Finance Corp. and local area banks. Every time the CEOs meet you, they find in you an ally, a great believer in financial sector reforms and consolidation in the banking landscape. Despite your best efforts you have not been able to do much on this front but they don’t blame you for this as they are aware of the opposition from the Left, without whose support the UPA government cannot survive.
Successive budgets have turned into empty promises as far as the Indian banking sector is concerned. For instance, in 2000, your predecessor Yashwant Sinha made a big-bang announcement of bringing down the government holding in public sector banks to 33%. But nothing has happened on this front yet. Another long-pending issue is the removal of cap on voting rights for private banks. Both Sinha and Jaswant Singh, former finance minister, announced the removal of 10% cap on voting rights in private sector banks. You too promised this in the 2005 budget but the necessary amendment to the Banking Regulation Act, 1949, is still awaited. Another contentious issue is foreign investments in Indian banks. While private banks can offer up to 74% stake to foreign investors, public sector banks cannot offer them more than 20%. Naturally, both sets of banks are bound of have different valuations on bourses. No finance minister has dared to discuss this in Parliament as this is again a politically sensitive issue.
But there are other issues that need your attention. They will not raise the red flag for the Left but if you address them, they will create a level playing field for the public sector banks. One such issue is the different tax structure for different savings instruments. For instance, one does not need to pay tax when one earns dividend from investments in mutual funds. Also, there is no capital gains tax if one stays invested in stock market for a year. However, bank deposits are subject to tax. It is an issue not for the public sector banks alone but the entire industry. This makes it difficult for banks to bring down their deposit rates as anyway a depositor does not earn much from keeping money with banks after paying income tax.
Public sector banks are also handicapped in attracting talent as they cannot pay market-related salaries to their employees. Your idea of giving performance-linked bonus to bank chairmen and executive directors is welcome but even after this, these executives will earn much less compared with private sector CEOs. Performance-linked bonuses for employees are even lower as the overall amount is capped at 1% of the net profit of a bank. This means, State Bank of India, the country’s largest bank, cannot pay more than Rs2,445.67 to each of its employees as bonus if it wants to pay all of them. Last year it earned a net profit of Rs4,533.98 crore and had 185,388 employees on its rolls.
Finally, a word on your stance on interest rates. Since the beginning of this century, The Reserve Bank of India (RBI) and the finance ministry have been working in tandem to bring down interest rates. In the 2001 and 2002 budgets, Sinha cut the administered rates. His successor Singh followed it up in 2003 with another cut. Each time, RBI reciprocated the finance minister’s gesture by paring the policy rates. The rate cuts helped corporations reduce the cost of borrowings and fuel economic growth. But you seem to be following a different path. In the past, when RBI raised its policy rates you did not want public sector banks to raise their lending rates and when RBI is holding on to its rates you want the banks to cut rates.
Two years ago, when these banks raised their rates, the banking division of the finance ministry had sent a note to the CEOs arguing why the rates should not be hiked. It also advised them to go ahead with the rate hike only after their boards ratify the decision. This time around, when some of the large banks cut their lending rates by 25 basis points to respect your wish, the bureaucrats in the banking division wanted them to cut 50 basis points and the banks had no choice but to oblige the ministry.
I remember shortly after assuming office in 2004, you had said that you would like to be remembered as the investment minister. Indeed you have noble intentions—you want the economy to grow and the country to prosper. But, because the government does not fully own these banks, it cannot force them to cut rates. This amounts to blatant violation of corporate governance. Public sector bankers have slowly started learning the tricks of the trade and are becoming nimble-footed. Please do not take away their right to compete. The other option before the government is to make banking for them a corporate social responsibility.
Wishing you another dream budget,
Tamal Bandyopadhyay keeps a close eye on all things banking from his perch as the Mumbai bureau chief of Mint. Please email comments to firstname.lastname@example.org