Clear the banking mess and let small businesses thrive–Economic Times–11.04.2018

It is disconcerting that half the country’s state-owned banks are now under the RBI’s watch-list for their deteriorating health. Reportedly, more banks could come under the so-called prompt and corrective action framework (PCA) that restricts lending activities of banks. This would hurt businesses, especially the small ones that do not have access to formal credit markets. This does not augur well for the economy.

There are many restrictions on banks under the PCA framework. These banks are not allowed to access costly deposits or take steps to increase their fee-based income. They will have to launch a special drive to reduce the stock of bad loans and check generation of fresh non-performing assets. They will also not be allowed to enter into new lines of business. So, the government may have to provide more capital in the months ahead, though these banks are likely to use the capital received to provide for bad loans.

An improvement in their financial performance hinges on how well the bankruptcy code works. The goal should be to minimise the haircut that banks take. This, in turn, will reduce the re-capitalisation burden on the exchequer and the tax-payer. But more real reform is needed to revive banks. That is not in the hands of banks, but the government. The ownership structure of banks and policy on remuneration of senior management needs an overhaul.

Creating a company to hold PSB equity will give banks more functional and operational autonomy, and also end bureaucratic meddling in appointments. Compensation of bankers must be de-linked from civil servants, as recommended by the Banks Board Bureau. Commercial decisions may entail losses at times, and the government must shun the culture that sees every loss making decision with suspicion.

Senior managers’ compensation should have a relatively low fixed component, with a lion’s share linked to long term performance of the banks. Simply put, salaries of senior managers who take decisions that expose banks to risks while offering the chance to generate profits must be linked to how well their decisions turn out over a period of time.

An improvement in the health of PSU banks will provide a breather to small businesses, many of whom borrow from money lenders at exhorbitant interest rates. Microfinance institutions (MFIs) made lending to these businesses cheaper than moneylenders. But many of them, especially in AP and Karnataka collapsed, closing a decent avenue of finance for small businesses. The conversion of some MFIs into small finance banks has, of course, helped lower the cost of funds.

But given that over 12 crore people are employed in the small scale sector, there is an urgent need to restore the health of state owned banks. The remedies to fix the ills of these banks can be debated till the cows go to the hills. What is needed is political will to implement banking sector reforms.

via Clear the banking mess and let small businesses thrive

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