Forget privatisation, consolidation of PSBs can prevent PNB-like scams | Business Standard Column–30.03.2018—–*****

The US President from 1945 to 1953, Harry S Truman, had a sign on his table that read “The Buck Stops Here”. It is unclear at whose table the buck stops in India. In the recently uncovered Punjab National Bank (PNB) scam case, first the government and then the Reserve Bank of India (RBI) have chosen to blame each other.

PNB’s multiple errors of commission and omission in the Nirav Modi case have resulted in that bank losing Rs 140 billion and counting. So far, only junior PNB officers have been identified as having colluded with the fraudsters. For taxpayers, who have to recapitalise public sector banks (PSBs) with metronomic regularity, the outraged breast- beating is about how this could have carried on for more than seven years without the connivance and incompetence of auditors and senior management at PNB.

The current status in the PNB case is that the government has committed to finding out who all were responsible and then to prosecute the guilty. As the bard says “Hope springs eternal in the human breast” and hopefully punishment, if it comes, will serve as a deterrent for the future. Based on innumerable precedents, a more likely outcome is that the investigation-prosecution will get bogged down and we taxpayers will have no option but to move on. Several of those accused have literally flown the coop. The Lalit Modi and Vijay Mallya examples indicate that proving Nirav Modi’s guilt in a foreign court and bringing him back to India will not be easy.

In the short time that has elapsed since the PNB fraud came to light, the discussion has already shifted from the specifics of this case to public versus private banks. The logic is that some in government abet and condone public sector bank personnel who engage in fraud. Hence once all banks are privatised there will be no fraud in the banking sector or at least the probability of theft will be greatly reduced.

Additionally, private sector bank proponents implicitly suggest that once PSBs are privatised there will be no future demands for taxpayer-funded financial support. Purely as a thought experiment let us consider an extremely low probability situation in which HDFC and ICICI banks become insolvent and there is a run on the deposits of these two banks. The Deposit Credit Guarantee Corporation insures depositors up to a ceiling of Rs 100,000. If domestic holders of larger deposits and foreign stock holders of these too-big-to-fail banks flock to the government, would it be able to deny funding support? Unless there is legislation which makes this practically impossible, the government is likely to succumb to pressures to provide solvency support even to private banks.

In the periodic financial-banking sector breakdowns in developed countries including in the US, the UK, Sweden, Italy and Greece private banks received funding assistance from taxpayers. The presumption that private banks auto-correct has been repeatedly proved wrong. Ex-post rationalisations are presented, but in most cases the taxpayers in the Organisation for Economic Co-operation and Development countries were hit both in cash flow terms and by the opportunity costs of growth foregone. And, almost always due to the greed and/or fraud of private sector bankers. The bottom line is that at a pinch governments are forced to provide liquidity-solvency funding support to private institutions to avoid systemic loss of confidence in their financial sectors.

All senior managerial and board member appointments and if necessary dismissals in Indian PSBs are approved by the Appointments Committee of the Cabinet (ACC), with the finance minister as the proposer and the prime minister as final arbiter. Does this government control over appointments/dismissals of PSB management matter more than RBI’s powers of regulatory oversight? PSB boards have serving Ministry of Finance and RBI officials. Although these two categories of board members could point out whatever does not make sense in writing to PSB management it is unlikely that they do so on sensitive matters. In such cases, the government, too, probably makes its preferences known to the PSB management quietly. The RBI conducts periodic inspections of all banks, including PSBs and it can stop any activity deemed to be fraught with undue market or operational risks.

A couple of the other PSB board members are professionals usually from the fields of finance, law or accounting and may provide technical feedback to the management. The remaining board members do not count since they are invariably close to the ruling political party in Delhi.

Would the appointment norms for heads of PSBs and board members change if government ownership is reduced to say 26 per cent? As a large shareholder, the government would probably continue with the present ACC system of appointments. The process of appointing senior PSB managers could be improved by restricting the government’s choices to names suggested by an independent panel of experts who have never worked for the government or the RBI. If the government is not satisfied with the names proposed it could ask the panel to keep returning with fresh names till the government makes its selections.

The suggestions to privatise PSBs make no reference to defaults involving large private sector borrowers. It is not just PSBs which have negative to low net worth. The flip side of the coin (twin balance sheet problem) is that large corporate borrowers get away without honouring their debt obligations. If change of ownership is the solution, should the government nationalise private sector firms which have defaulted on their debt obligations? Unlike all the data that is in public domain about the financial health of PSBs, comprehensive and loan-specific information about borrower defaults is not publicly available. The RBI’s reasoning that the Banking Regulation Act forbids it from providing such information, despite a December 16, 2015 Supreme Court ruling to the contrary, is not convincing.

To sum up, the government should retain the better performing of the PSBs, namely State Bank of India and Bank of Baroda. All other PSBs need to be bought out by these two banks but at prevailing market valuations.


j.bhagwati@gmail.com. The writer is RBI chair professor at ICRIER and former Ministry of Finance official

via Forget privatisation, consolidation of PSBs can prevent PNB-like scams | Business Standard Column

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