September 22, 2005

Indian Banks on Limited Freedom

Asia Times, 23.09.2005

India's banking system has been generally stable, with low and falling non-performing assets (NPA) ratios, growing deposits and profits in the post-liberalization period of the past decade. However, as India hopes to improve on its growth rate from the compounded year-on-year average of 5–6% to 7–8%, this clearly is not enough for the government.

Recently, Finance Minister Palanippan Chidambaram, himself an ardent reformist, gave public sector banks a severe dressing down for projecting lesser-than-satisfactory growth trajectories. The main reason why Chidambaram pulled up the banks was their recent anticipation of a "slowdown in deposit mobilization and credit disbursal targets".

Speaking at the annual general meeting of the Indian Banks Association, he said, "Public sector banks have been consistently outperformed by the new private sector banks in deposit mobilization. Some of the frontline public sector banks

have projected a lower deposit growth in 2005–06 than 2004–05."

This comes at a time when, despite global crude prices of more than $70 a barrel, the growth estimates of the economy for 2005–06 have been revised upward from about 6.5% to 7%. Naturally, credit extension of the major banks should have increased along with this spurt in economic activity. To be fair to Chidambaram, he did acknowledge that. Where he did chide the bankers and advised them to "remedy their perceptions" was their comparative performance vis-a-vis the burgeoning private banks. However, the government may be more to blame than the bankers.

As outlined earlier, the major government-owned banks have been doing brisk business. Take State Bank of India (SBI), the largest of them, as an example. Its total deposits rose from $52.09 billion in 2000–01 to $83.91 billion in 2004–05, its operating profit was up from $850 million to $2.51 billion and its net NPA ratio down from 6.03% to 2.65%.

Similarly, Punjab National Bank (PNB), the third largest bank, saw its revenues rise from Rs96.46 billion ($2.19 billion) in 2003–04 to $2.30 billion in 2004–05, and its operating profit rose from Rs27.07 billion in 2003–04 to Rs31.21 billion in 2004–05.

However, this rosy picture fades when compared with the performance of major private players in the market, despite them being considerably smaller in size both in terms of operational capability as well as market share.

For example, ICICI Bank, the largest private sector bank, increased its deposits by nearly 47% between 2003–04 and 2004–05, compared to a meagre 15% for SBI over the same period. Similarly, the operating profit margin (operating profit as percentage of revenue) for HDFC Bank increased to nearly 36% in the first quarter of 2005 from the same quarter of 2004 vis-a-vis a 32% figure for PNB

The fact that India's public sector "Goliaths" are falling behind the private sector's "Davids" is what caused the recent irritation expressed by the finance minister. Yet the reason lies in the ad hoc nature of banking sector reforms. Successive finance ministers have warned the public sector banks "to brace for a wave of consolidation" to become global players. However, calling for world-beaters does not produce them; visionary and consistent policy does.

First, domestic mergers and acquisitions are hampered to a great degree by the vociferous opposition of trade unions. Labor reforms Delhi promised are nowhere in sight, and banking strikes are frequent in the public sector – sometimes asking for an impossible pay rise, sometimes protesting against feared job losses due to any proposed mergers.

Second, government banks have been constrained in their capital-raising capability due to political roadblocks. Raising foreign investment caps has always proven difficult, and initial public offerings (IPOs) have been slow to come. The banks have not really hit the markets with an IPO spree, as many smaller private banks have done in recent times.

The proportion of shares on the market remains small anyway. Moreover, apparently to hold the banks accountable, the government has recently reiterated its stand of holding controlling stakes in these banks. A K Purvar, managing director of SBI, has plans for some major acquisitions, and yet is "waiting for government notification" before he can raise preference capital for this purpose.

Third, government control necessarily translates into government intervention, much of which is arbitrary and hampers efficiency. The Central Vigilance Commission (CVC) regularly exercises its powers of purview, which creates a "fear psychosis" among bankers and slows down operations. Recently, however, the government has instructed the CVC to reduce its jurisdiction and stop intervening in top-level managerial decisions. Nonetheless, this remains at the proposal stage and is being discussed between the comptroller and auditor general of India, along with other government agencies before it translates into reality.

Furthermore, the government still appoints the board of directors and chief executives of these banks, along with the Reserve Bank of India appointing the auditors. On the other hand, the RBI appoints only one of the auditors in private sector banks, while the rest are appointed by shareholders. Ironically, this creates much greater accountability than in the public sector banks, despite the government retaining control for precisely this reason.

Foot-draggers say that the expectations of the Finance Ministry are "over-ambitious and unrealistic". Yet public sector banks are strategically better placed than their private competitors, with greater market penetration and opportunity to get economies of scale. Yet the return on assets ratio of these banks remains at 0.7% compared to 1.6% in government banks in Brazil, 1.42% in South Korea, 1.36% in Malaysia and 1.2% in Singapore.

It should be said that the performance of the public sector banks is not bad by most standards. For example, they have a far bigger role in extending rural credit than private sector banks. Agricultural lending rose to Rs1.5 trillion, which is Rs100 billion above the target, while NPAs are down by Rs21 billion. Cumulative profits are at Rs377.37 billion. SBI, PNB, Andhra Bank, Bank of Baroda and Oriental Bank in various parts of Africa and Asia are planning major foreign acquisitions.

So, where's the problem? The point is that they could be better. And a dose of continuous, consistent and pragmatic reform is what is needed.

Aruni Mukherjee is based at the University of Warwick, UK, and takes a deep interest in the political economy of the Indian subcontinent. He is originally from Kolkata, India.


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