On 7 June, the Union ministry of finance despatched a letter to the chairmen/managing directors of sponsor banks. The letter indicated that the Union government, in consultation with the National Bank for Agriculture and Rural Development (Nabard), had decided to go ahead with phase III of the amalgamation of regional rural banks (RRBs). This will bring down the total number from 56 to 38 and ensure that most of the smaller states have only one RRB, while the larger might have two.

There is a lot to be said about the merits of this decision (as well as the previous decisions) of amalgamating RRBs cutting across sponsor banks. First, these banks, when they were set up, were seen as alternatives to cooperatives, adding a touch of professionalism to the local feel a cooperative society provided. They were seen as decentralized solutions for the skewed banking development that was happening across the country, with the south and west being well banked while the north-east, east, and central regions suffered. While we do have large nationalized banks for the purposes of banking services in general, RRBs provide services proximate to the rural customer. There are merits in the argument that size reduces overheads, makes regulation easier and optimizes the use of technology. But what is the additional benefit it creates for customers? Given that these banks are completely state owned, they possibly need to look at whether or not the mergers allow for providing better services to the customer at the margins. I believe that a greater centralization is in fact going to take RRBs away from the customer at the margins.

While the merits of that argument can be debated, let us look at the blatant travesty when it comes to corporate governance. This decision is not being taken in unusual times where the banks are in distress and customer interests are to be protected. Even then, it would be the Reserve Bank of India (RBI) rather than the government that would take this call. These are decisions taken in cold blood. If that is the case, what is the role of the respective boards of the RRBs, and the boards of the sponsor banks? The government does not seem to be carrying out even a token consultation with the RRBs’ boards. Of course, they are substantially owned by the government. The Union government has a 50% stake, the respective state governments, 15%, and the sponsor banks have a 35% stake. There is no indication that the Union government consulted the respective state governments. The letter from the ministry is terse. It just asks the chairmen/managing directors to send a no-objection before a certain date. That is it. It does not expect anybody except the people in the ministry to apply their minds to the proposal. The forced merger of RRBs without consultation of the owners can only be seen as tyranny. This is a warning bell for the public-sector banking reforms that might be in the offing.

The sponsor banks are listed entities. Do their boards not need to discuss the proposal, at least to safeguard the interests of the minority shareholders? While materially this may not make a difference to the overall financials of the banks, is it not a strategic decision to let go of a portion of the ownership and, thereby, a strategic hold on the outlets of the RRBs where there could be synergies for the parent bank? Should this be a political decision or a business decision? And, finally, what is the basis for valuing the shares? Is there a professional valuation being done?

Even in the case of public sector banks, there is constant talk about the Union government wanting to merge some banks and have a few larger banks. We saw that with the associate banks of the State Bank of India (SBI) getting merged with the SBI (and the chairperson getting an extension of tenure just to oversee this merger process). There is much chatter on the possibility of large-scale merger proposals. These, when they happen, will be legally valid because the government has the power to do so under the Bank Nationalisation Act. But is this the most appropriate way of going about the task? After all, these are large listed institutions that not only have minority shareholders but a large number of depositors whose savings are at stake. Does the bureaucracy have the necessary expertise to understand the nuances and see the merits of the mergers? What should be the reform agenda? Should we not first identify the horse and the cart and then get the sequence right?

Governance reform should perhaps start with making public sector institutions more accountable to market discipline. Move them from the Bank Nationalisation Act to the Companies Act, make them accountable to the Securities and Exchange Board of India, and address the concerns expressed by the RBI governor about a level playing field in the supervision and regulation of public sector banks by removing all the exemptions under the Banking Regulation Act. This would make them more accountable with regard to their strategy and financials to a larger set of analysts. This would also help them discover their strategic positioning. The next step would be to move towards reducing the government stake, both directly and indirectly. Not only does the government own these entities directly, it also exerts control through institutions controlled by the government such as the Life Insurance Corporation of India. Once that is done, the state has to ensure that there is an interested single promoter-like shareholder.

The process of identifying the buyer who controls the entity could be through a process similar to what the RBI follows in licensing new banks. Once management is divested to a block of shareholders other than the government, those shareholders could look at mergers, acquisitions and other aspects based on market conditions and merits.

What we have now is a set of non-market players determining the fate of market-based institutions without even paying lip service to stakeholders’ accountability. This throws corporate governance norms to the winds.

This has to change. The sooner, the better.

M.S. Sriram works with the Centre for Public Policy, Indian Institute of Management, Bangalore. Comments are welcome at theirview@livemint.com

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