Mumbai: The Reserve Bank of India (RBI) and the government should reduce the differences in regulatory treatment between public sector banks and private sector banks over the medium term, central bank governor Raghuram Rajan said on Tuesday.

“Authorities should ensure their actions are institution, ownership and technology neutral so as to ensure that the most efficient customer-oriented solutions emerge through competition," Rajan said at a banking conclave organized by the Federation of Indian Chambers of Commerce and Industry and the Indian Banks’ Association.

If, however, authorities deliberately skew the playing field, competition may not be efficient, he said, pointing to the example of state-owned banks.

Apart from meeting all the regulatory requirements like private banks do, public sector banks also have to follow government diktats such as opening Pradhan Mantri Jan Dhan Yojana accounts and extend MUDRA loans for micro units. They are also stuck with rigid hiring rules, which require them to recruit only through all-India exams.

Public sector banks do get more government deposits and business, and are backed by the full faith and credit of the government, Rajan said, adding that while it is unclear whether the cost of the mandates outweigh the benefits, they do skew the competitive landscape.

“Some of the differences between public and private banks can be mitigated if the government pays an adequate price for mandates," he said.

To reduce the variation in regulations for public sector and private sector banks, the RBI has been consistently bringing down statutory liquidity ratio holding requirements, and allowed over half of these holdings to meet the Basel-mandated liquidity coverage ratio.

An internal RBI panel is studying what a branch truly means and how it can serve the most number of people in the least expensive structure, he said.

As competition increases, however, the authorities should ask how long mandates should continue, and keep targeting them better towards the truly underserved. They should also withdraw any preferential treatment, to the extent feasible, at a commensurate pace, he said.

In a highly-competitive environment that is emerging in the banking sector, public sector banks also have to deal with some inherent struggles that are built in the way they are structured. While bad loan management is something that Rajan describes as the most pressing task, equally important is governance and acquisition of talent with expertise in project evaluation, risk management and IT including cyber security, he said.

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Rajan pointed out that even though the Bank Board Bureau (BBB) has taken over the appointment process in banks, the final decisions are still being taken by the cabinet’s appointments committee.

Appointments of non-official directors on bank boards still lie outside the BBB. As the BBB gains experience, it would make sense to allow these decisions also to be taken by it, Rajan said.

Similarly, public sector banks are also struggling with thinning middle management ranks due to retirements and low pay grades among top employees, which leads to them not being able to attract the top crop of managers. Rather than seeing these as challenges, Rajan said, they must consider promoting talented youngsters and provide them with necessary training.

An increased emphasis on performance evaluation, including identifying low performers with the intent of helping them improve, may be warranted. In addition, rewards like employee stock ownership plans that give all employees a stake in the future of the bank may be helpful. With public sector bank shares trading at such low levels, a small allocation to employees today may be a strong source of motivation, and can be a large source of wealth as the bank’s performance improves, he said.

Banks must also focus on hiring more local talent at their branches since these employees come up with an inherent understanding and information about the area and relationships that are already built.

There is a situation of overlap of many authorities governing public sector banks right now, he said, with the government’s department of financial services, Parliament, the regulator and the vigilance commission all monitoring their activities.

Going ahead, much of the governance will have to move to the boards of the individual banks, rather than with multiple authorities, Rajan said.

He also said RBI would perform a purely regulatory role, and withdraw its representatives on bank boards—this will require legislative change.

Over time, RBI should also empower boards more, for instance, offering broad guidelines on compensation to boards but not requiring every top compensation package be approved.

“Given strong oversight from the bank’s board, the Central Vigilance Commission and Comptroller and Auditor General would get involved only in extraordinary situations where there is evidence of malfeasance, and not when legitimate business judgment has gone wrong," the RBI governor said.

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