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Solutions Remain Elusive for Solving the Problems at India’s Public Sector Banks

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The Pulse

Solutions Remain Elusive for Solving the Problems at India’s Public Sector Banks

Bank sector consolidation could address India’s non-performing loan crisis, but political realities make resolution uncertain.

Solutions Remain Elusive for Solving the Problems at India’s Public Sector Banks
Credit: CC0 image via Pixabay

Many Indian government-owned enterprises remain chronically unprofitable and laden with debt. As pressure mounts on Prime Minister Narendra Modi to deliver on his reform mandate, the government is presenting plans to privatize or consolidate state-owned enterprises across the economy – including in banking.

The country’s banks (both private and public) lent extensively over the past decade betting on a sustained global economic recovery. Even though the Indian economy grew at 7.1 percent in 2016-17, looser lending criteria have saddled bank portfolios with non-performing loans.

S. Vishwanathan, Deputy Governor of the Reserve Bank of India (RBI), called the issue a “major challenge” and noted that the stability of the banking system worsened over the past year due to lower profitability and deteriorating asset quality. Eighty percent of the bad loans in the system have been made by publicly-owned banks.

Moody’s estimates that $14.3 Billion (₹95,000 crore) in equity capital will be needed to stabilize the banking system. As a signatory of the Basel III accord, Indian banks will also have to meet higher capital reserve requirements starting in 2019.  So far, the government has budgeted only a fraction of this amount (₹10,000 crore) in 2018 and 2019 as part of its Indradhanush plan to address the shortfall.

“The government and the Reserve Bank are in dialogue to prepare a packet of measures to enable the [public sector banks] to shore-up the requisite capital in a time bound manner,” said RBI director Urjit Patel at a summit on the Bankruptcy and Insolvency Code.

Some of the solutions he proposed were tapping public markets, selling the government’s a portion of the government’s stake, injecting additional capital, selling non-core assets and facilitating mergers.

Of those options, the government currently seems to favor directing stronger banks to merge with smaller and weaker ones to improve the overall health of the banking system. The finance ministry recently announced plans to consolidate India’s 21 state-owned banks into approximately a dozen institutions.

While the situation might change in the future, the government is currently asking the boards of state-owned banks to voluntarily produce merger plans instead of forcing consolidation.

Mergers are not a politically costless option, however. Consolidation will lead to layoffs and India’s organized labor is prepared to resist.  In August, one million bank employees from the United Forum of Bank Unions staged a nation-wide strike to protest the new policy.

Management consultancy Oliver Wyman said that these labor issues could be addressed with special programs such as employee stock ownership plans.

For now, little progress has been made in shrinking the number of banks.  With upcoming elections in critical states such as Gujarat, Karnataka, Rajasthan, Madhya Pradesh, it remains to be seen if the Modi government is willing to spend the political capital required to advance the agenda.  Despite its best efforts, the previous UPA government could not deliver on the same goal.

“The Indian banking sector is close to breaking point,” wrote the analysts at Oliver Wyman.  “We read almost daily about the initiatives taken by the Reserve Bank of India, [and] the government…what we have yet to see is a comprehensive vision of how the sector can return to sustainability.”