The discussion
about State
Bank of India (SBI) has treated one proposition as a given: that
it is the job of the Ministry of Finance to continually inject capital
into SBI so as to enable the growth of the SBI balance sheet; that SBI
has a legitimate claim upon fiscal resources at all times.
I'm not sure this is a good way to think about the business of
banking. The first task of a bank should be to produce adequate
retained earnings so as to support the desired growth. If a bank
cannot produce retained earnings enough to grow, there is reason for
thinking that it should not grow.
Let's compare the performance of the best private bank
(HDFC
Bank) and a good PSU bank
(Bank
of Baroda) from this perspective.
Growth of the balance sheet and leverage
Let's look at how the two banks have fared, from 1999-2000 onwards,
on the core issues of balance sheet growth and leverage:
| 1999-2000 | 2010-11 | |
| Bank of Baroda | ||
| Total assets | 58,623 | 358,397 |
| Leverage | 18.12 | 17.07 |
| HDFC Bank | ||
| Total assets | 11,731 | 277,429 |
| Leverage | 15.33 | 10.93 |
From 1999-2000 to 2010-11, there has been a sharply superior
performance by HDFC Bank. At the start, it was a small bank - with a
balance sheet of just Rs.11,731 crore while BOB was roughly 5x
bigger. By the end, HDFC Bank was at a balance sheet size of
Rs.277,429 crore while BOB was at Rs.358,397 crore.
What is more, HDFC Bank did this while being more prudent: they
deleveraged in this period: They went from a leverage ratio of 15.33
to a leverage ratio of 10.93. In contrast, BOB stayed at a much higher
leverage (18.12 at the start and 17.07 at the end).
The bottom line: BOB grew net worth by 6.5 times and the balance
sheet by 6.11 times. HDFC Bank grew net worth by 33.17 times
and the balance sheet by 23.65 times.
So how did the net worth grow?
In the naive intuition that's being bandied about in the discussion
about SBI, there would be an expectation that the expansion of net
worth would be obtained by asking shareholders (new or existing) for
money. What happened in HDFC Bank and BOB was a bit different.
The hallmark of a healthy bank is the production of retained
earnings which can be ploughed back into the business. HDFC Bank did
that: over this period, it brought 13.23% of total assets (summing
across the 12 years) back into the business, so as to grow net
worth. BOB did not do as well: it brought only 7.86% of total assets
back into the business.
In addition, HDFC Bank raised 13.66% of total assets by bringing in
fresh capital. BOB, in contrast, brought in only 2.11% of total assets
into the business. You could criticise the Ministry of Finance for
being niggardly in giving BOB equity capital.
Summary
A well run bank must put retained earnings back to work. If a bank
is unable to fund its own growth by increasing net worth through
retained earnings, there is reason to be concerned about the
health of the core business.
A steady flow of new capital from shareholders, in order to enable
growth, is not that different from recapitalisation in response to bad
assets.
Public money is precious. The Ministry of Finance would do well to
be very, very stingy in doling out public money to PSUs. Each Rs.5000
crore that goes into a PSU comes at an opportunity cost of 1000
kilometres of NHAI highways which could have been built using that
money.
If a PSU cannot grow its balance sheet, odds are the problem lies
within: it needs to become a better run business and thus grow the
balance sheet using retained earnings. Such PSUs are precisely the
ones who are the least deserving to gain fresh capital. If anything,
fresh capital should be directed into banks like HDFC Bank (as the
private capital markets have), who are doing a great job of producing
retained earnings.
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