If public sector banks fail, the government loses a fundamental instrument of development
In a powerful and inspiring speech at NITI Aayog last week, Prime Minister Narendra Modi warned that incremental progress was no longer enough; India, he said, needed to embrace transformational change. We cannot march through the 21st century with the ideas and administrative system of the 19th century.
Few sectors need to embrace the Prime Minister’s message with greater urgency than banking. India’s public sector banks are facing a serious crisis. This is not a new observation. What is widely under-appreciated, especially by the banks themselves, is the magnitude of the crisis. It is existential.
The world has changed profoundly while public sector banks haven’t adapted adequately. The staggering amount of bad loans is merely the tip of the iceberg. The bigger worry is the rapid loss of market share to private sector competitors. In the past year, private banks accounted for a whopping 68% share of new loans; as a result the market share of public sector banks is expected to decline to 60% or even less within the decade.
The fundamental reason for this is the lack of competitiveness and differentiation. One respected deputy governor of the Reserve Bank of India was candid enough to recently admit that there is little to differentiate one bank from another besides the signboard. Add more regulatory oversight, 13 new banks and tens of well funded entrepreneurial fin-tech startups hungry to disrupt these behemoths and you have a perfect storm.
Navigating and surviving a perfect storm requires clarity and decisiveness. The contours of the solution to this wicked problem are fairly well understood. The P.J. Nayak Committee laid out the problem, the diagnosis and remedies with admirable candour. This led to Mission Indradhanush, which has the essential ingredients to help the banking sector get well again. In his final speech to FICCI and IBA, departing RBI governor Raghuram Rajan summarized what needs to be done with clarity and frankness.
The key to transformation lies in a massive upgradation of talent and culture of these organizations—the software more than the hardware. Like every business, banking has become a knowledge and technology intensive enterprise. Banking now requires incredible depth in areas such as risk management, project evaluation, treasury, credit evaluation, fraud detection, real-time monitoring of millions of streams of data, and deep analytics.
In other words, banking is now an information business in which IT becomes the central nervous system. It is no wonder that globally banks are the biggest users of IT with the best banks competing with Google and Facebook to hire PhDs in computer science, mathematics and physics. In the face of these trends, the HR policy framework that governs the functioning of our public sector banks is horribly archaic and hobbling.
Banks lack the ability to hire the brightest youngsters from our best colleges. Compensation is a huge disincentive; the chairman of India’s largest and extraordinarily well run State Bank makes less than a tenth of her private sector counterparts. Legacy promotion policies make it next to impossible to develop depth and expertise in important areas. A recruitment freeze in the 1990s has resulted in the decimation of the senior ranks and few real role models of effective leadership. Performance management systems discourages differentiation and a real meritocracy.
It is not that there aren’t lots of good, bright people in these institutions; the real issue is that the conditions for them to blossom into accomplished high performing leaders simply do not exist. Nor is large scale lateral hiring from the private sector the panacea. The challenges of integration make this a tool that must be used with discretion. The most pernicious aspect of the situation is that everyone understands these issues but no one seems able or willing to change the rules.
A related challenge is one of governance. Bank boards are emasculated entities with little real authority. Boards do not appoint the managing director or the executive directors nor do they have the authority to incentivize or manage performance or terminate management. As a result, public sector bank boards do not have the single most important tool to perform their fiduciary duty. Boards lack the authority to hire directors who can bring much needed expertise or perspective; these issues were to be handled more effectively by the Bank Boards Bureau but the BBB is currently focused on only the appointment of whole-time directors.
In his speech to FICCI-IBA, governor Rajan pointed out risk of bank MDs getting conflicting perspectives and direction from everyone including Parliamentarians, RBI, the finance ministry, BBB and the board of their own banks. It is a rare board indeed that is able to ensure compliance, short term performance and have an intelligent and informed dialogue about medium and long term strategy. The risk is that most banks will lurch from crisis to crisis and quarter to quarter without adequately addressing the fundamental issues of leadership, talent, culture, strategy and capability.
If Mission Indradhanush isn’t put on steroids, if the mandate of the Bank Boards Bureau isn’t strengthened, if the twin issues of governance and HR aren’t addressed decisively and urgently, the most likely scenario is one of atrophy. Public sector banks will lose their best customers at an accelerating rate to private sector competitors. Fin-tech will disrupt more and more of their business leaving these institutions with costly infrastructure and no viable business model. Bad loans will bubble up again. Taxpayers will have to subsidise their existence.
Banks are fundamentally unlike other businesses. If HMT or Air India withers or gets wound up, customers don’t care; the private sector seamlessly steps in leaving everyone better off especially the taxpayer.
However, if public sector banks fail, the government loses a fundamental instrument of development. Who will lend to large infrastructure projects? Will private sector banks serve population segments that are not lucrative or in remote locations? How will priority sector lending happen? Having abdicated education and healthcare to the private sector with serious consequences, our government inadvertently risks vacating the banking sector as well. But can markets be trusted to serve all the needs of a developing nation of a billion people? Or is there a continuing but selective need for well-run public sector banks?
As Darwin said, in nature it is neither the biggest nor the strongest that survive but those most adaptable to change. India’s public sector banks have to change quickly. In the pithy words of our PM, they have to “reform, perform and transform" or decline into irrelevance.
Ravi Venkatesan is the chairman of the Bank of Baroda. The views expressed here are personal.