Sunday, June 01, 2014

Top IIM-A professor opposes plea to privatize govt banks, meant to bring them off right to information purview

TT Mohan Ram
By Our Representative
Close on the heels of a high-level Reserve Bank of India (RBI) committee wanting the public sector banks (PSBs) to be removed from under the purview of the Right to Information (RTI) Act by privatizing them, a top professor of the Indian Institute of Management-Ahmedabad (IIM-A) TT Mohan Ram has opposed the view that the state should distance itself from banking boards in order to privatize banks, which would bring them out of the RTI. According to Prof Ram, the “solution” found by the RBI committee, headed by PJ Nayak, ex-CEO Axis Bank, is, the government should “let its stakes in PSBs fall below 50 per cent” by allowing “government shareholding” to be “transferred to a Bank Investment Company (BIC)”, which is unacceptable.
“If boards in the private sector are such paragons of virtue, the committee must tell us why some of the biggest banks in the U.S. and the U.K., whose boards were packed with glittering names from the corporate world, collapsed in the financial crisis of 2007”, wonders the IIM-A professor. Pushing for privatization in order to drop the banking sector from the right to information (RTI) purview (click HERE to read), the committee had said, the banks must “level the playing field for public sector banks in relation to their private sector competitors” by reducing government “holding in banks to less than 50 per cent.”
Prof Ram says, the committee wants that “the Bank Nationalisation Act and other related Acts must be repealed and PSBs brought under the scope of the Companies Act. The BIC would appoint members of boards of PSBs as well as their CEOs and executive directors.” And what would happen as a result? “It would let its stakes in PSBs fall below 50 per cent so that banks are freed from limits on remuneration, the right to information Act and the jurisdiction of the central vigilance commissioner.”
Pointing out that the committee believes the right to information Act and the jurisdiction of the central vigilance commissioner over the PSBs are two major “vexations”, he says, the committee thinks, by removing “vexations”, the PSBs can “single-mindedly focus on profit maximization”. Eventually, “the BIC would transfer its ownership powers to the bank boards. The government’s stake in the BIC itself would fall below 50 per cent, thereby privatising these banks. We would enter a brave new world of Indian banking liberated from the stranglehold of government ownership.”
Telling Jaitley that loosening state control and eventually privatizing PSBs is “fraught with both political and economic risk”, Prof Ram has said, “Government ownership has been a factor underpinning stability in banking.” The issue particularly becomes significant because, in his view, the new finance minister, Arun Jaitley, will sooner or later come to grips with PSBs, “which account for over 70 per cent of assets in the banking system, are bogged down by a rise in non-performing assets.” He cites the example of how public sector undertakings in Gujarat turned around recently to say this experiment may also be replicated for the nationalized banks.
Saying that this has “eroded their profitability and limited their ability to raise the regulatory capital needed to make loans”, the IIM-A professor has said, the view taken by the committee headed Nayak, who is also former country head Morgan Stanley Bank, “rests on the presumed superior efficiency of private sector banks”. He adds, the committee “thinks that if only the government gave up its controlling function and became a passive investor instead, it would stand to make enormous returns on its shareholding.”
Giving financial reasons for opposing privatization of nationalized banks, the IIM-A academic says, “It is based on a comparison of performance of PSBs and private sector banks at a time when PSBs are weighed down by the problems of the economy at large.” He adds, “It would be more appropriate to compare performance over a longer period. A wide range of academic studies points to a trend towards convergence in performance of PSBs and private banks since banking sector reforms were set in motion in 1993-94.”
Saying that the Nayak committee suffers from “what is called survivor bias” believing that banks can only live within the private sector framework, Prof Ram insists, “Several new private sector banks licensed after 1994 have ceased to exist. Precisely for this reason, they would not be found in the private bank group used for comparison. This lends an upward bias to the performance indicators of private banks.”
Then, Prof Ram says, “The comparisons ignore the scope of activities of PSBs and private banks. PSBs have an important development role. They took upon themselves the task of funding private investment in infrastructure which was an important driver of growth in the boom period of 2004-08. Private banks can be more choosy about what they wish to fund. Many are focused on the retail segment, working capital and wealth management. Foreign banks make enormous profit out of their capital markets division alone. If PSBs were to adopt such a narrow focus, sectors that are crucial to the economy would be starved of credit.”
“From a flawed starting point”, the professor says, “The committee moves on to a diagnosis and a prescription that are even more flawed. The committee thinks the PSBs are doing badly because their boards are dysfunctional. The government packs the boards with its own people. The boards go through the motions of approving proposals put up by the management. Little thought is given to issues of strategy and risk management. In contrast, private banks have high-quality professionals on their boards that provide sage counsel. This, the committee contends, is what explains superior private sector performance.”
Giving why privatizing banks cannot be a solution, Prof Ram says, “To cite only one example, the U.K. regulator, the Financial Services Authority (FSA), looked into the collapse of the Royal Bank of Scotland, the biggest banking failure in the country’s history. Its report noted that there was an almost complete lack of questioning and challenge on the part of the board in the critical years when the bank hurtled towards ruin. There was nothing wrong with the composition of the board.”
“Boards in general are dysfunctional, whether in the private sector or the public sector. The remedies must, therefore, be generic in nature. The Companies Act 2013 and clause 49 of Securities and Exchange Board of India’s listing agreement now contain clauses that are intended to improve the functioning of boards, in particular, that of independent directors”, he says.
He further says, “In banking, the regulator needs to go further. ‘Fit and proper’ criteria for board members must be strengthened and the RBI might adopt the FSA’s practice of interviewing candidates proposed for a directorship on a bank board. For banks above a certain size, there could be a requirement that positions be advertised and nominations sought from eminent persons so that a wide pool of talent is tapped. The RBI may stipulate that bank boards contain expertise in areas such as risk management and marketing of financial services. Board effectiveness could be measured using outside experts.”
Saying that there is more to it than the larger social purpose of banking, the professor says, “Our experience has been that government ownership has been a factor underpinning stability in banking. The world over, economies have faced banking crises over the past several decades. Banks failed, they were nationalised or bailed out, then turned over to the private sector. This is the phenomenon of socialisation of losses and privatisation of profits that has come to attract public outrage.”
Suggesting that India’s experience has been “refreshingly different”, the scholar says, “The Indian approach has been to have the public sector dominate banking while exposing it to competition. In the process, efficiency has improved without jeopardising stability. Experience has shown that it is possible to retain the public sector as the sheet anchor of the banking system without compromising on efficiency.”

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