State-owned Dena Bank’s scrip fell almost 6% to .`17.65 on Monday, after the Reserve Bank of India (RBI) directed the bank not to issue any fresh loans or hire personnel due to a surge in bad loans. This is not unexpected. The bank’s books must be cleaned up to nurse it back to health. Reportedly, other banks that are under the so-called prompt and corrective action (PCA) worry that a similar directive by the RBI would dent their business. A ban on fresh lending would crimp future interest income.
The working capital requirements for existing clients would be squeezed if banks are banned from giving credit. So, the worries of public sector banks (PSBs) that have weak operational and financial metrics are not entirely misplaced. Eleven out of the 21 state-owned banks are under PCA due to mounting bad loans, weak capital levels and low return on assets. PCA is warranted to limit the damage that these banks can do to the system.
These banks face restrictions on dividend, branch expansion and directors’ compensation. They must put the bankruptcy code to use to clean up their books and explore fee-based opportunities. The government should also infuse capital in banks that build up their balance-sheets so that they can start lending afresh. Some state-owned banks that want to merge for valid commercial reasons to consolidate should be allowed to do so, provided they meet tougher loss-absorbing capacity norms.
The ownership structure of PSBs and the policy on remuneration needs an overhaul to give banks more functional and operational autonomy. Real reform is to create a holding company that owns a majority of the equity in every public sector bank. Bonds, rather than bank loans, should fund large, long gestation infrastructure projects.
This piece appeared as an editorial opinion in the print edition of The Economic Times.
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