by Harsh Vardhan.
What would you say if someone was borrowing money at 8% and
investing it to earn around 3%? "Uninformed!", "financially
illiterate!" or even outright "foolish"! And yet this is what our
government has been doing with trillions of rupees over the last
many years and has committed to continue to do so in the future.
The process by which this is done is called capitalisation of
public sector (PS) banks. Such capitalization is not only a bad idea
economically as it puts enormous stress on the government resources,
but also one which affects that behavior of banks and hence the
robustness of the whole banking sector.
Commercial banks need capital to grow.
Capital adequacy requirements ask all banks
to keep a minimum amount of shareholder capital in proportion to their
balance sheet size. Currently,
in India this requirement is 9% of "risk weighted assets" of banks.
Roughly, it means that banks are expected to have equity capital which is
9% of their commercial loans.
As banks grow their business, their risk weighted assets also
grow. This means that banks has to increase their capital base in
line with the growth of their loan book. Such increase in capital can
come from exactly two sources - retained profits that are added to the capital
base, or fresh infusion of capital from shareholders (old or new). In
India, given the overall profitability of the banks (~1.1% return on
assets) and the amount of dividend that they pay (~20%) of post-tax
profits, banks do not have enough retained profits to
support their business growth. Therefore, every now and then, they
go to shareholders to raise fresh capital.
PS banks pose a peculiar challenge for the government. Being the
majority owner of these banks and having committed to stay the
majority owner, government has to infuse capital into these banks
proportional to its ownership stake. Since the government
wants to maintain its ownership at 51%, it has to supply atleast
51% of the fresh capital that PS banks need. RBI governor Dr.
Subbarao, in a recent speech, said that the capital infusion by
government into PS banks over the next decade will be of the order of
Rs.0.9 trillion. I have read estimates of other analysts where this
number is as high as Rs.2.50 trillion. These estimates depend on
the assumptions one makes about a number of factors - the rate of growth
of banks (which in turn depends on the growth of the overall economy),
the profitability of banks, their dividend policy, their ability to raise
other forms of capital (especially tier II capital), regulatory
requirements on capital, etc. No matter how you estimate it, the number
is very large. In other words, the government will be compelled to
invest a very large amount of capital into PS banks over coming
years.
Why is this a problem? Let’s look at the some simple public finance
issues. India is in a deep fiscal crisis, and it is not easy to find
trillions of rupees to put into PS banks. If such resources were
injected into PS banks, it is not conducive to healthy public finance,
since these injections are not a good deal for the government.
The Indian government currently
borrows long term money at over 8%. The dividend yield on PS banks
shares has been between 2% and 3% over the last decade. This means
that the government earns between 2% and 3% on its investments in PS
banks. There is a 5% “negative carry” or loss that government
bears on these investments.
A private investor also earns a low
dividend yield from investing in PS banks, but can benefit from
capital gains - a potential increase in the
value of shares which the investor can obtain when she sells the
shares. Government has never sold shares of PS banks (except when it initially
listed some banks) and will not do so if it has to maintain majority
ownership which is its stated policy. Hence, for the government, the
financial analysis of a proposal to put money into PS banks should
hinge on a comparison between the flow of dividends versus the cost of
borrowing.
Capitalisation of PS banks is, thus, bad for government finances.
It's a double whammy! On the one had government has to raise vast
resources to be invested into banks and then carries a loss of around
~5% on these investments year after year.
Ownership and behavior of banks
Government capitalisation of PS banks is not just a fiscal challenge. It also
impacts the competitive dynamics of the banking industry. Most
privately owned banks are under constant scrutiny of investors and
analysts. When they go to external investors for raising capital, they
have to satisfy these investors on number of critical aspects of the
business - profitability and its sustainability, efficiency of capital
use, quality of management team, cost efficiency, etc. In other words,
private banks face a market test; they do not get capital for
free. Only well run private banks get equity capital that is required
for growth.
None of these
questions get asked when government puts capital into a PS bank.
One has never heard a senior government official commenting on
the Return on Asset (RoA) or Return on Equity( RoE) of PS banks. The
decision to put capital into PS banks is treated as a mechanical and
administrative decision. This absence of a market test has systemic
consequences. PS
banks have ~70% share of the Indian market. When the majority owner is
asking no or very few questions on performance, and is assuring an almost
unlimited supply of capital, these banks have little incentive to
improve financial metrics such RoA and RoE. This hurts the overall
banking industry. For example, PS banks can underprice
loans compared to their private sector peers. Such behavior
would migrate the whole business to lower returns. It is hard for a
private bank to be profitable when facing rivals that are not
concerned about return on capital.
Misplaced obsession with majority ownership
The source of this whole capitalisation issue is the government's
obsession with retaining majority (over 51%) ownership of PS
banks. This is often explained in terms of the need to maintain the
"public sector character" of these banks. While there may be a separate
debate on whether we need to maintain public sector character for all
the 25 plus PS banks, the fact is that the government does not need
majority ownership to achieve this objective.
All PS banks are not companies under the Companies Act. The notion
of 51% giving majority control is enshrined in the Companies Act. PS
banks were created under the Nationalisation Act (SBI has its own SBI
Act). The Nationalisation Act provides the government untrammelled
control over these bank. While it does prescribe 51% government
ownership in the PS banks, the control of government is independent
of the level of its ownership. Furthermore, there is a limit of a 5% (10%
with prior approval of the RBI) stake owned by any single shareholder in
all banks. There is no chance, therefore, of any external shareholder
acquiring control in these banks. Even relatively minor changes to the
functioning of PS banks require approval of the parliament. Where is
then the question of diluting the public sector character if the
government ownership were to drop to, let's say 26%, which is the
threshold for "significant" minority stake in a company?
In the long run, therefore, it makes no sense for the government to
commit itself to the capitalisation of PS banks. Precious
government resources can be better deployed in critical areas (such
as power transmission and distribution) where private capital on large
scale is hard to come by. In the medium term, it can use tactical
measures such as merging banks where it has significantly high
ownership with those where the ownership is already down to 51%.
But these tactics will not solve the issue structurally. The only long term
solution is to give up the majority obsession, explain to all the
stakeholders the fallacy of this obsession and the resulting
pressure on public finance, build a political consensus to enact necessary
legislative changes and then dilute down to a reasonable level.
0 comments:
Post a Comment