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The budget proposals to strengthen public sector banks (PSBs) are welcome. On the one hand, they seek to relieve banks of their bad loan burden by setting up an asset reconstruction company (ARC) and transferring the non-performing assets (NPAs) to the ARC. On the other, it proposes to augment bank capital, eroded by provisioning against bad loans. One route to recapitalise the banks is for the government to put in more capital. Another is to bring in fresh investors and bring the government’s stake below 50%, that is, privatise the banks in question. This is a welcome strategy. Banks would not lend, unless freed of their NPA burden. And retaining ownership of some banks in the public sector and focusing on capital infusion to make them strong, while letting others be owned and controlled by non-State operators, would make them more robust as well.
Raising capital from the public will give the government more fiscal room, reduce the taxpayer burden to recapitalise banks, allow PSBs the freedom to go outside the trail of vigilance and fix their own remuneration plans. Not unexpectedly, bank unions want a rollback of the privatisation plan. The government must engage with the unions. An essential requirement is to improve the regulation and supervision framework that would make the nature of ownership inconsequential for the working of the bank. Raising equity capital from the public is a superior option to burdening the taxpayer for recapitalising banks. Preferential allotment of shares to bank employees could smoothen the transition. Global capital is available now in plenty, and cheap. Strengthening supervision, and internal systems, especially risk management, will inspire investor confidence to draw the capital needed.
But PSBs need to overhaul their current decision-making structure and culture. Market-linked remuneration must replace current, repressed salaries. Fintech and a bond market should keep banks on their toes. Senior bankers’ pay must be tiered, with larger components linked to medium- and long-term performance, subject to clawback.
This piece appeared as an editorial opinion in the print edition of The Economic Times.