This newsletter is really a weekly public policy thought-letter. While excellent newsletters on specific themes within public policy already exist, this thought-letter is about frameworks, mental models, and key ideas that will hopefully help you think about any public policy problem in imaginative ways. It seeks to answer just one question: how do I think about a particular public policy problem/solution?
India Policy Watch: Rajan-Acharya on PSB Reforms
Insights on burning policy issues in India
Raghuram Rajan and Viral Acharya have a new paper titled, Indian Banks: A Time To Reform?, that looks at a comprehensive set of reforms that will enable public sector banks to drive the Indian economic growth engine instead of being a drag they currently are. Rajan and Acharya have held leadership roles at the RBI and know a thing or two about issues relating to the banking sector.
So, what to make of them?
There are 4 points we’d like to raise:
- Is this the time? Rajan and Acharya argue maintaining status quo is untenable. The huge strain on government finances now shifts the Overton window for much-needed reforms of the public sector banking system. This is their hope. In my view, shifting the status quo at this time carries the risk of falling off the brink. There’s a fog of uncertainty about the duration of the pandemic, the state of our public finances and the nature and length of recovery. More than any immediate reform we need some stability, however precarious, at this moment.
- What about the empire? The paper reiterates the need for a systemic solution to the bad loan problem. The idea for a nationalised and a private “bad bank” is revived along with a strict time-bound process for bankruptcy procedure. The recent books by Urjit Patel (who succeeded Rajan) and Acharya have outlined in great detail how there’s no incentive for anyone in the political economy or in the banking sector to implement the IBC process. Everyone is happy kicking the can down the road. Any attempt at enforcing strict insolvency guidelines is met with resistance. Patel named the relevant chapter in his book ‘The Empire Strikes Back’. And this resistance to change was the state of affairs before the pandemic. So, to expect a serious reckoning by the government now is out of question. In fact, we seem to be going the other direction. The suspension of IBC is to be extended by another quarter and the restructuring proposal by Kamath committee leaves the discretion with the bank on triggering default procedure. We will have to learn to live with elevated levels of NPAs and banking system stress especially in public sector banks (PSBs).
- Who will implement them? There are proposals to improve the performance of PSBs through greater operational freedom, performance-linked bank financing plans and winding down the Department of Financial Services (hah!). While these are good intentions, operationalising them in a system that has bloated cost structure, unionisation and relatively lax performance management culture won’t be easy. There are suggestions that are akin to the Kamath committee on giving loans based on cash flow and liquidity position of the companies instead of their assets. More aggressive norms for provisioning for bad loans and making sure the promoters have skin in the game in long-term infrastructure projects are also suggested. There are other suggestions to manage banking system risks better that have been around for some time. But implementing them will mean standing up to the ‘empire’.
- Is stake sale the panacea? Finally, we have the issue of the ownership structure of banks. The paper proposes bringing the stake of the government below 50 per cent (state-linked banks) and gradual privatisation of select PSBs. While this step to create a distance between it and the everyday operations of the bank is necessary, this alone won’t address the governance issues of the PSBs. There’s an entire superstructure (the ‘empire’) that manages and lives off the PSBs that includes unions, bureaucrats, various oversight committees and temporal political interests. This influences everything from recruitment, performance management, promotions, disbursement guidelines to risk management practices. This won’t change overnight merely because the government stake is below 50 per cent.
Read the full edition here.
Disclaimer: Views expressed on Anticipating the Unintended are those of the authors’ and do not represent Takshashila Institution’s recommendations.