The Reserve Bank of India (RBI) is under pressure from the government to relax the norms of its prompt corrective action (PCA) framework that has put wide-ranging restriction on banks on lending.
Close to a dozen public sector banks (PSBs) are under PCA framework, monitored by RBI with lending restriction till they nurse back to good health. In an election year, no government would want state-owned banks to not support the small businesses. The government's concerns are justifiable but as an owner, they also have to address the issues that pushed these banks to restricted lending mode. In good times, a wild and a reckless strategy easily passes through the test of a good bank. But it is the tough and challenging times that separate the wheat from the chaff. A tough period also throws open the cracks in the business model. The Indian banking system, especially the public sector banks (PSBs), are completely exposed. Here are the bigger issues the banks are dealing with:
i) Lack of capital
PCA framework applies on banks whose capital slips below the minimum regulatory threshold of 9 per cent. These PCA banks have been starving for funds for long because of inadequate capital as government finances are too tight. These banks are not in a position to raise capital on their own. For example, the market capitalisation of fifth largest bank Bank of Baroda is just Rs 27,000 crore. The mid- sized Dena Bank has a market cap of Rs 3,500 crore. In fact, the market cap of these banks is far lower than some of the non-banking financial institutions (NBFCs) in India. There is not enough capital in these banks to kick-start lending to SMEs or MSMEs.
ii) No let-up in deteriorating asset quality
The second criterion for PCA is unusually high non-performing assets (NPAs) of over 10 per cent. Higher NPAs are not good for the health of a bank as it reflects poor credit standards and failure to recover loans through collateral. These banks need higher provisioning from profits to provide for any future losses before kick-starting any fresh loans. The SME or the MSME segment is too risky to lend at these times. These banks are better off doing fee-based business or retail loans, which don't require much capital and have historically lower NPAs.
iii) Balance sheet clean-up drive is already underway
For long, the banks were known for kicking the can down the road to avoid NPAs. This approach changed after RBI governor Raguram Rajan assumed office in 2013. He started the exercise to clean the balance sheet of banks. Governor Urjit Patel has also continued the clean-up drive at the banks. This is a good long-term exercise along with a good recovery and restructuring mechanism of bankruptcy code. These measures would stabilise with some short-term pain. Any relaxation on PCA framework at this stage will derail the process, which may have longer term negative implications.
iv) Not much on the governance or reform front
There is a bigger issue of governance reforms in PSBs. There are some half-hearted measures like Bank Board Bureau (BBB), but it doesn't have many powers. The next logical step of having an investment holding company for all the PSBs also does not look in sight. The government recently experimented with having outside professionals, especially in Bank of Baroda, but now the government has decided to merge the three banks --Vijay Bank, Dena Bank and Bank of Baroda. But the issue of ownership (holding company, autonomy, and governance reforms) still hangs.