The Prime Minister Mr. Modi, the Finance Minister Mr. Jaitley and the Reserve Bank
Governor Mr. Raghuram Rajan are expected to attend a banking retreat near Pune on 3
January, where the agenda is to figure out how to fix
public sector banking. The meet is being organised by the NIBM , Pune.Public sector banks are
the engines of economic growth as they account for almost 75 percent of the
banking industry but these engines have been stalling of late as bad
loans have flooded their books. As the RBI’s Financial Stability Report,
released yesterday (29 December), pointed out, gross NPAs of Indian banks (including
public sector ones) were 4.5 percent of total advances as at the end of
September 2014, and stressed assets were 10.7 percent. This means
nearly 15 percent of bank assets are bad or have the potential to go
bad, but the figure is much more higher for public sector banks as any internal employee/auditor of these Banks knows.Public
sector banks are thus inefficient users of manpower and capital, as
they lend to unworthy crony
capitalists or to segments of the population where the cost of
delivering banking services is very high. Their balance-sheets are thus
under acute strain.
The essential problems that need addressing when they meet on 3 January are thus three: how to make public sector banks survive on less capital even while having to raise more capital in the short run; how to make the banking workforce more productive; and how to make top managements actually accountable so that public sector banks can compete better with private bankers.
Efficient Capital: The three sources of capital are government infusions, raising money from the secondary market, and more internal generation of surpluses to shore up capital. HDFC Bank, for example, has raised almost no new equity for more than a decade. Its capital needs are generated from profits. On the other hand, the State Bank of India seems to require capital infusions from the government almost every year.
In the short run, public sector banks should thus be allowed to raise more equity from the markets, as government holdings are comfortably above 52 percent in most banks. But, over the next three years, as this leeway gets used up, the government will have to dilute its stake below 52 percent. To raise more money from the markets and yet retain control, government will have to either issue a new class of shares with differential voting rights for its own shares or it will have to accept privatisation. Big banks like State Bank of India can also raise capital by selling minority stakes in their subsidiary banks and insurance offshoots. However, the real remedy for public sector banks is to improve their profitability by better management. As economist Ajay Shah observed in an earlier blog: “If a bank is unable to fund its own growth by increasing net worth through retained earnings, there is reason to be concerned about the health of the core business. If a PSB cannot grow its balance-sheet, odds are the problem lies within: it needs to become a better run business and thus grow the balance-sheet using retained earnings. Such PSBs are precisely the ones who are the least deserving to gain fresh capital.”
He compares the performance of HDFC Bank and BOB over a decade to show the difference. “From 1999-2000 to 2010-11, there has been a sharply superior performance by HDFC Bank. At the start, it was a small bank - with a balance-sheet of just Rs 11,731 crore while BoB was roughly five times bigger. By the end, HDFC Bank was at a balance-sheet size of Rs 277,429 crore while BoB was at Rs 358,397 crore. What is more, HDFC Bank did this while being more prudent: they deleveraged in this period: They went from a leverage ratio of 15.33 to a leverage ratio of 10.93. In contrast, BoB stayed at a much higher leverage (18.12 at the start and 17.07 at the end). The bottomline: BoB grew net worth by 6.5 times and the balance-sheet by 6.11 times. HDFC Bank grew net worth by 33.17 times and the balance- sheet by 23.65 times.”
The point is simple: PSBs must become more efficient users of capital. They cannot remain capital guzzlers and be run the way they are. Here are three broad options ?
Managerial autonomy: Quite clearly, they need top quality managers at the top, and good managers may need better pay and perks than what they currently are eligible for. This is not to say existing public sector managers are not good but if they also need to be paid better and allowed the freedom to run their banks efficiently. The government should specify the deliverables from the top management and then leave it alone for, say, 3-5 years, to work on the plan. Performance alone should determine the selection of who will run public sector banks and not just seniority.The selection of bank chiefs and top managers should be made autonomous of the normal government processes, with their heavy political biases.Another way would be for the government to offer top managements higher compensation through equity – based on performance parameters achieved.The key focus area for autonomous managers will be employee productivity. Here, they will end up colliding with the bank unions, which tend to be powerful. So the changes have to be implemented in stages, so that natural attrition and voluntary retirements takes care of the deadwood.
Employee productivity: The key difference one notes between efficient foreign and private banks and not-so-efficient Nationalised banks is their officer-to-total manpower ratio. Put simply, nationalised banks use too many low-skilled employees bunched under the categories of clerks and sub-staff, data released by the RBI yesterday show.For example, foreign banks have 92 percent of their total staff as officers. HDFC Bank, Axis Bank and Axis Bank have nearly 100 percent of staff in the officer category. As opposed to this, nationalised banks have only 46 percent in the officer category, and the State Bank group even less (36 percent).Is it any wonder public sector banks are inefficient? Having more non-officer staff also means more unionism.But fear of job losses needs to be addressed head on. India’s 1.15 million bankers are not going to lose jobs just because of the likely down-sizing that will happen with greater efficiency. In fact, with the creation of new kinds of banks – payment banks, small banks, etc – the banking industry is going to explode in terms of jobs and growth potential. But the growth will happen only in high-skilled jobs. The real job in the nationalised banking sector is upskilling of the younger staff, and generous voluntary retirement payments for the older staff who can’t change with the times.
Indian banking needs new thinking, and the Prime Minister should use the banking retreat in Pune to push big changes in how public sector banks are managed. Even if privatisation is off the agenda, autonomy and market-determined pay and performance assessments ought not to be.
The essential problems that need addressing when they meet on 3 January are thus three: how to make public sector banks survive on less capital even while having to raise more capital in the short run; how to make the banking workforce more productive; and how to make top managements actually accountable so that public sector banks can compete better with private bankers.
Efficient Capital: The three sources of capital are government infusions, raising money from the secondary market, and more internal generation of surpluses to shore up capital. HDFC Bank, for example, has raised almost no new equity for more than a decade. Its capital needs are generated from profits. On the other hand, the State Bank of India seems to require capital infusions from the government almost every year.
In the short run, public sector banks should thus be allowed to raise more equity from the markets, as government holdings are comfortably above 52 percent in most banks. But, over the next three years, as this leeway gets used up, the government will have to dilute its stake below 52 percent. To raise more money from the markets and yet retain control, government will have to either issue a new class of shares with differential voting rights for its own shares or it will have to accept privatisation. Big banks like State Bank of India can also raise capital by selling minority stakes in their subsidiary banks and insurance offshoots. However, the real remedy for public sector banks is to improve their profitability by better management. As economist Ajay Shah observed in an earlier blog: “If a bank is unable to fund its own growth by increasing net worth through retained earnings, there is reason to be concerned about the health of the core business. If a PSB cannot grow its balance-sheet, odds are the problem lies within: it needs to become a better run business and thus grow the balance-sheet using retained earnings. Such PSBs are precisely the ones who are the least deserving to gain fresh capital.”
He compares the performance of HDFC Bank and BOB over a decade to show the difference. “From 1999-2000 to 2010-11, there has been a sharply superior performance by HDFC Bank. At the start, it was a small bank - with a balance-sheet of just Rs 11,731 crore while BoB was roughly five times bigger. By the end, HDFC Bank was at a balance-sheet size of Rs 277,429 crore while BoB was at Rs 358,397 crore. What is more, HDFC Bank did this while being more prudent: they deleveraged in this period: They went from a leverage ratio of 15.33 to a leverage ratio of 10.93. In contrast, BoB stayed at a much higher leverage (18.12 at the start and 17.07 at the end). The bottomline: BoB grew net worth by 6.5 times and the balance-sheet by 6.11 times. HDFC Bank grew net worth by 33.17 times and the balance- sheet by 23.65 times.”
The point is simple: PSBs must become more efficient users of capital. They cannot remain capital guzzlers and be run the way they are. Here are three broad options ?
Managerial autonomy: Quite clearly, they need top quality managers at the top, and good managers may need better pay and perks than what they currently are eligible for. This is not to say existing public sector managers are not good but if they also need to be paid better and allowed the freedom to run their banks efficiently. The government should specify the deliverables from the top management and then leave it alone for, say, 3-5 years, to work on the plan. Performance alone should determine the selection of who will run public sector banks and not just seniority.The selection of bank chiefs and top managers should be made autonomous of the normal government processes, with their heavy political biases.Another way would be for the government to offer top managements higher compensation through equity – based on performance parameters achieved.The key focus area for autonomous managers will be employee productivity. Here, they will end up colliding with the bank unions, which tend to be powerful. So the changes have to be implemented in stages, so that natural attrition and voluntary retirements takes care of the deadwood.
Employee productivity: The key difference one notes between efficient foreign and private banks and not-so-efficient Nationalised banks is their officer-to-total manpower ratio. Put simply, nationalised banks use too many low-skilled employees bunched under the categories of clerks and sub-staff, data released by the RBI yesterday show.For example, foreign banks have 92 percent of their total staff as officers. HDFC Bank, Axis Bank and Axis Bank have nearly 100 percent of staff in the officer category. As opposed to this, nationalised banks have only 46 percent in the officer category, and the State Bank group even less (36 percent).Is it any wonder public sector banks are inefficient? Having more non-officer staff also means more unionism.But fear of job losses needs to be addressed head on. India’s 1.15 million bankers are not going to lose jobs just because of the likely down-sizing that will happen with greater efficiency. In fact, with the creation of new kinds of banks – payment banks, small banks, etc – the banking industry is going to explode in terms of jobs and growth potential. But the growth will happen only in high-skilled jobs. The real job in the nationalised banking sector is upskilling of the younger staff, and generous voluntary retirement payments for the older staff who can’t change with the times.
Indian banking needs new thinking, and the Prime Minister should use the banking retreat in Pune to push big changes in how public sector banks are managed. Even if privatisation is off the agenda, autonomy and market-determined pay and performance assessments ought not to be.
