R Gandhi: Public sector banks - at cross road
Speech by Mr R Gandhi, Deputy Governor of the Reserve Bank of India, at the "Indian PSU
Banking Industry: Road Ahead" Summit, organized by the Bengal Chamber of Commerce
and Industry, Kolkata, 10 January 2015.
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Assistance provided by Ms Anupam Sonal is gratefully acknowledged.
Ladies and Gentlemen!
1. It is a pleasure and privilege to be among the banking and industry participants at
this Conference on "Indian PSU Banking Industry: Road Ahead" organised by the Bengal
Chamber of Commerce and Industry. The theme of the Conference is very contemporary. In
recent times, the PSBs position in the banking pecking order has been seriously challenged.
There are lot of churning of ideas to restore greater strength in them. I thought today I can
discuss certain thoughts which I feel are very important for the PSBs to seriously consider in
that respect.
2. India has a real long history of banking. According to the Indian Central Banking
Enquiry Committee (1931), money lending activity in India could be traced back to the Vedic
period, i.e., 2000 to 1400 BC. The existence of professional banking in India could be traced
to the 500 BC. Kautilya's Arthashastra, dating back to 400 BC contained references to
creditors, lenders and lending rates. After the independence of the country in 1947, keeping
in tune with the then economic policy, banking sector was highly regulated. The public sector
banking commenced in India with the nationalisation of the then Imperial Bank as State Bank
of India in 1955. One of the defining moments of Indian banking industry is the bank
nationalisation in 1969, when 14 private sector commercial banks were nationalised. In the
aftermath of a balance of payment crisis situation in 1991and with the advent of economic
reforms India embarked upon financial sector liberalization in a phased manner. Banking
industry was deregulated by way of allowing entry of new private sector banks; ten new
private Indian banks were set up in 1993, followed by two banks in 2003. Other notable
features towards deregulation of banking sector included allowing 74% foreign investment in
private sector banks, doing away with licensing of branches of domestic scheduled
commercial banks in a phased manner, deregulation of interest rates, widening and
deepening of financial markets, etc.
3. Indian banking sector comprises of different types of institutions to cater to the
divergent banking needs of various sectors of the economy. There are typical commercial
banks which operate on all India basis. There are government owned banks, privately owned
banks and foreign owned banks. There are also small banks with limited areas of operation.
Credit cooperatives were created to cater to the credit, processing and marketing needs of
small and marginal farmers organised on cooperative lines. Cooperatives expanded also in
urban and semi-urban areas in the form of urban cooperative banks to meet the banking and
credit requirements of people with smaller means. Regional Rural Banks were created to
bring together the positive features of credit cooperatives and commercial banks and
specifically address credit needs of backward sections in rural areas. Further, there was an
experiment of establishing Local Area Banks, albeit on a smaller scale, to bridge the gap in
credit availability and strengthen the institutional credit framework in the rural and semi-urban
areas. Most recently, we have decided to experiment with new types of banks under our
differential licensing policy. Accordingly, we have invited applications for Small Finance
Banks and Payment Banks. These banks will operate in their own niche areas of small
finance and payments services.
4. In India, the universal banking model is followed. As regards the structure of
universal banks, the conglomerate structure is bank-led, i.e., banks themselves are holding
companies which operate certain businesses through Subsidiaries, Joint Ventures and
Affiliates. The general principle in this regard is that para-banking activities, such as credit
cards, primary dealer, leasing, hire purchase, factoring etc., can be conducted either inside
the bank departmentally or outside the bank through subsidiary/ joint venture /associate.
Activities such as insurance, stock broking, asset management, asset reconstruction, venture
capital funding and infrastructure financing can be undertaken only outside the bank. Lending
activities must be conducted from inside the bank. Investment banking services are provided
by the banks as an in-house departmental activity or through subsidiary.
5. The Indian banking system has grown phenomenally over the years. What has been
the actual contribution of banks for mobilizing savings and engineering investments in the
Indian economy? The aggregate deposits which stood at just ₹ 8 billion as on March 1951,
grew to ₹17 billion by March 1961, ₹59 billion by March 1971, ₹380 billion by March 1981,
₹1925 billion by March 1991, ₹9629 billion by March 2001 and ₹52080 billion by March 2011.
As at end March 2014, it reached ₹85,331 billion. The Bank credit increased from ₹5 billion
as at end March 1951, to ₹13 billion by March 1961, ₹47 billion by March 1971, ₹254 billion
by March 1981, ₹1164 billion by March 1991, ₹5114 billion by March 2001, ₹39420 billion by
March 2011 and ₹67352 billion by March 2014. The branches which stood at 8262 in 1969
expanded to 1,16,450 by March 2014. The other types of touch-points numbered 3,37,678 as
at end March 2014. The number of ATMs were 1,60,055 as on that date.
6. The major share of this growth story belongs to the public sector banks. PSBs
dominated the banking system with a market share of 72.1% as at end March 2014 distantly
followed by NPBs (15.9%), FBs (7.2%) and OPBs (4.9%). As at end of March 2014, the total
capital of the PSBs stood at ₹5652 billion; their share in total deposits was 77.22%, share in
total advances was 75.74%. However, their CRAR was 11.40%, against 13.01% of all banks.
Their gross NPA was 4.36% vs 3.83% of all banks: their total stressed assets were 10.67%
vs 9.03% of all banks. If we look at the corresponding figures for the New Private Sector
Banks at CRAR of 16.59%, gross NPA of 1.73% and total stressed assets of 3.28%, we get
a feeling of the tight spot that the PSBs find themselves in today. If we look at their
performance ratios, a deep despondency sets in. The PSBs' ROE was very low at 9.71 as at
end March 2014 vs 17.06 of the NPBs. ROA was at 0.50 vs 1.83.
7. The PSBs need a hard relook on their structure, functioning methods and financial
and risk management.
a. Firstly, Capital Planning for PSBs needs to be considered over a long term horizon.
Approximately, as high a sum of ₹4.50 lakh crore in Tier 1 capital (which includes ₹ 2.40 lakh
crore equity capital) will be needed. Recently, it has been reported that the GOI is
contemplating scaling down their holdings in PSBs to 52%. This may not be sufficient to fully
meet the capital needs of the PSBs under Basel III norms particularly since the projections
are based on minimum requirements. We also have to remember that Pillar II assessment
has not taken off effectively/ fully as of now. The PSBs will have to chart out a clear capital
raising plan over the next five years. The PSBs should actively consider several options
including, non-voting rights share capital, differential voting rights share capital, golden voting
rights share capital, etc.
b. Secondly, there is a need to reflect on the Holding Company Structure in respect of
the PSBs. The Nayak Committee recommendations in the matter look at the Bank
Investment Company Structure from the limited perspective / single angle of separating the
GOI investments from the PSBs. There are deeper ramifications on this aspect and the
whole issue must be looked at from multiple dimensions including that of the financial
stability perspective. The suggestions made in the Shyamala Gopinath Report on the Bank
Holding Company structure need to be given a serious consideration. The objective must be
threefold - i) help reduce capital requirement impact on the GOI ii) financial stability
perspective, and iii) strengthening corporate governance by reducing government influence
and interference;
c. Thirdly, the Performance Appraisal System (PAS) needs a complete revamp.
Currently the PAS makes no meaningful distinction between individuals for identifying or
deploying talent, skills and / or specialisation; nor does it guide determining compensation.
The system needs reshaping so as to serve as the mainstay for evaluating employees'
performance, assessing compensation and developing leadership.
d. Fourthly, the Public Sector Banks (PSBs) have hardly any meaningful participation
in the financial markets, i.e in the BCD instruments. This restricts / curtails the financial
market development. A selected set of foreign banks and the new Private Sector Banks
dominate the financial markets in India. PSBs need to engage proactively, especially, in the
derivative instruments for hedging their risks. Treasury function is relatively weak in PSBs.
Well established and robust Treasury is a must for the purpose; they must build up
specialisation and should have sufficient number of specialists. The vigilance aspect on
treasury losses/ losses from transactions will need to be rationalised just as in other areas of
PSB operations.
e. Fifthly, the PSBs should have a relook on their portfolios. Currently, their portfolio
share in advances to agriculture, industries, services, retail and other services account for
13.90%, 46.32%, 20.93%, 15.74% and 3.11%. They will need to rebalance this, from the
perspective of diversification.
f. Sixthly, the Retail Banking in PSBs needs a complete overhaul in terms of products,
instruments and methods for deployment. As India is poised for re-entering high growth
period, and as greater number of individuals will have higher income and higher financial
needs, PSBs should be ready to meet these needs.
g. Seventhly, the PSBs should look at financial inclusion as a profitable business
proposition and not as a matter of compliance with the RBI and government requirements.
Extensive and smart use of ICT, mobile and internet banking as well as the Aadhaar linkage
for customer identification and authentication can make this truly possible. Banks need to
come out of the brick and mortar branch set-up mindset, and reorient the business models in
accordance with changing times and requirements as well as improve profitability. We must
not distrust the ability of the rural and/ or poor, small and marginal businesses/ operators/
farmers to understand and use basic / simple technology. The mobile and internet revolution
in India has proved that already.
h. Eighthly, the PSBs should grab the opportunity offered to them during the Gyan
Sangam, the retreat for the PSB chiefs at Pune last week. Now that Government has clearly
articulated that the PSBs will take their own commercial decisions, the PSBs will have no
excuse hereafter for any poor performance.
i. Ninthly, level playing field is on the cards. Already banking regulations and priority
sector norms are increasingly owner agnostic. Now government also desires that the PSBs
are professionally managed and operated. This augurs well for the PSBs.
8. To conclude, we can easily agree that the PSBs are at the cross road. They are now
being increasingly enabled to compete on professional basis. They are being assured of
autonomy for their commercial decision making. Given these changed environment, it is time
that they deliver value for the nation which provides its capital.