A joint paper by former Reserve Bank of India (RBI) governor Raghuram Rajan and former deputy governor Viral Acharya have suggested ways to make India's banking sector more agile and competitive. The research paper, which focuses on the challenges faced by the public sector banks, suggested that the best way to transform the state-owned lenders is by increasing efficiency, competition and variety.
The economists said that public sector banks might perform better if they are freed from court-mandated new entry-level hiring constraints that hiring can be done through open exams, which makes it hard for PSBs to attract candidates from elite educational institutions, who have little desire to sit for yet another exam.
"PSBs need to be able to recruit laterally, while retaining the talent they have, but to do so they need to be able to promise employees adequate compensation, responsibility, as well as the freedom of action. Unfortunately, employee actions in public sector banks are constrained by government rules and second-guessed by vigilance authorities, even while pay is limited. It has been hard therefore for public sector banks to compete for talent," the paper said.
Rajan and Acharya said that PSBs had the best talent, but past hiring freezes decimated their middle-management ranks, while private banks and multinationals also poached talented personnel from the state-owned banks.
The paper claimed that the PSBs' performance also suffer in the process of fulfilling the government mandates. It also cited the recent push into MSME lending under the Mudra scheme which has turned into bad loans.
"With the government strapped for funds, its ability to support the capital needs of public sector banks as part of the second grand bargain has been eroded," it said.
Despite inadequate support from the government, undercapitalised public sector banks tend to revert to financing the government rather than taking risks on new corporate or retail lending, the research paper said, adding that such "lazy lending" is a serious impediment to the growth of productive parts of the economy, even if it keeps the banks relatively safe on paper.
Besides, the lack of profitability at PSBs has also affected their ability to service their core deposit franchise well, so they are slowly but steadily losing deposit share to private banks.
"They cannot keep veering from bouts of crazy lending - where they make losses and deplete capital - to lazy lending - where they lend to the government but not to the private sector - and back. Their limited current capabilities have to be seen as the central impediment to Indian banking's progress, and it has to change if India is to have any hope of high rates of growth. Before that, however, the balance sheets of many public sector banks (and some private banks) have to be restored to health," it said.
The duo also suggested scrapping Financial Services Department to provide bank boards and management independence. They also called for introducing longer terms for senior management, better assessment of performance, performance-based promotions and extensions as a reform for the public lenders. The paper argues about tweaking ownership structures at banks. Rajan and Acharya suggest trimming government stake below 50 per cent in some PSBs and re-privatisation of some of these banks.
By Chitranjan Kumar