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Opinion

Is bank denationalisation the next big ticket reform?

It promises to be India’s biggest upcoming financial sector reform, maybe, by default or by a more subtle design. The government stands to lose control of all the public sector banks (PSBs) if it fails to pump in at least Rs 70,000 crore over the next 66 months into their equity capital to retain a minimum 51 per cent stake in them to comply with Basel III norms. The amount – lately calculated by the Reserve Bank of India as per the existing net worth and capital adequacy ratio (CAR) of each of these banks — could be even larger depending upon the status of their non-performing assets (NPAs) over this period. To retain the existing level of state control, the government should be ready to inject about Rs 90,000 crore or more as fresh equity contribution to the capital of these banks. The process is due to start before the close of the current fiscal year as per the Basel accord.

The fund-starved UPA government, having little control over its burgeoning fiscal deficit, may defer its phased equity contribution or provide for some trickles to these banks’ equity capital until next election, forcing the next government to bear the entire financial burden or opt for denationalisation of banks, ending an era of over four decades of state control of commercial banks. The next alternative could be to take the risk of ignoring the Basel III stipulation on re-capitalisation of banks, which is regarded tough even by the western world’s large multinational banks giving rise to a growing controversy over the practicability of stringent Basel III regulations and complex requirements and their overall impact on the banking system. But, that is unlikely to happen, as India is a signatory to the Basel III compliance and supervision agreement. A non-compliance of Basel III regulations by Indian banks will have a serious adverse impact on their profile by global rating agencies.

In December 2010, the Basel Committee on Banking Supervision (BCBS) agreed to new rules, outlining global regulatory standards on bank capital adequacy and liquidity, as agreed to by the Governors and Heads of Supervision, and endorsed by G-20 Leaders, including Indian Prime Minister Manmohan Singh, at the November 2010 Seoul summit. The new rules require financial institutions around the globe to hold more and higher quality capital, introduce a global liquidity framework, and establish a countercyclical capital buffer.

According to RBI Governor D Subbarao, Indian banks will require an additional capital of Rs 5 lakh crore to meet the new global banking norms, Basel III. The government owns 70 per cent of the country’s banking system. Fiscal constraints pose significant challenges to the government to re-capitalise banks to help them meet the Basel III norms. But, bringing down its holdings to below 51 per cent can help tide over the problem, he pointed out. Of the total Rs 5 lakh crore (Rs 5 trillion) to be required for re-capitalisation, the equity portion will be of the order of Rs 1.75 lakh crore and Rs 3.25 lakh crore as non-equity. The government has two options – either to maintain its shareholding at the current level or bring it down to 51 per cent to retain its control, Subbarao said.

However, the RBI governor was not sure if the government would be open to reducing its shareholding in PSBs to below 51 per cent. If the government decides to pursue this option, ‘an additional consideration is whether it will amend the statute to protect its majority voting rights.’ Of the Rs 1.75 lakh crore Tier I capital required to meet Basel III norms, PSU banks may have to raise from the market Rs 70,000-1,00,000 crore depending on how much the government will provide as its equity contribution. Over the past five years, banks have raised equity capital worth only Rs 52,000 crore from the market. And, not many of them have lived up to investors’ expectations.

It is true that the Basel III has lately come under fire from both central banks of large countries and global banking tsars. At a recent conclave of central bankers of the world at Jackson Hole, Andrew Haldane, head of financial stability at the Bank of England, had gone to the extent of calling on regulators to rip up the Basel accord that had underpinned financial oversight since 1988 and start again with simpler rules based more on ‘supervisory judgement’ than a ‘ticked box approach’. He also urged banks to respond to market pressure and break themselves up in a re-run of the 1930s, the ‘great depression’ era. Proposals to ring-fence retail banking in the UK and ban proprietary trading in the US ‘may not go far enough’, he said, as rules may be watered down through ‘backdoor complexity.’

Regulation has chased financial innovation unsuccessfully, Haldane said. To meet the new Basel III rules alone, Europe’s banks will have to create 70,000 new full time compliance jobs, he calculated from a McKinsey study. ‘Modern finance is complex, perhaps too complex. Regulation of modern finance is complex, almost certainly too complex,’ he said. ‘Applying complex decision rules in a complex environment may be a recipe not just for a cock-up but catastrophe.’

However, these extreme views apart, central banks and other authorities are today focused on what regulatory changes can promote market stability and help prevent a recurrence of the events that led to the recent financial crisis. There is a general agreement among regulators that capital requirements need to be tightened globally, and that more attention should be paid as well to the liquidity that banks can make available to combat runs on their fund during moments of panic.

There is also general agreement that, in order to avoid uneven playing fields and the related problems of regulatory arbitrage, such capital and liquidity frameworks should be globally accepted and implemented by financial institutions. The rules also include: capital incentives for banks to use central counterparties for over-the-counter derivatives; higher capital requirements for trading and derivative activities, as well as complex securitisations and off-balance sheet exposures; and the introduction of liquidity requirements that penalise excessive reliance on short term, interbank funding to support longer dated assets.

It would be wrong to assume that state-owned and protected commercial banks in India can follow different norms. The requirement of re-capitalisation under Basel III is one of most important norms. If the government fails to meet the requirement to retain its ownership control of the PSU banks, it can escape only through their privatisation by allowing majority private control. Incidentally, one should not forget that the country’s two largest private sector banks – ICICI Bank and HDFC Bank – have their roots in the erstwhile government-promoted Industrial Credit & Investment Corporation of India and the Housing Development Finance Corporation. [IPA]
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