On PSU Bank Merger - Missing the Woods for the Trees

Mr. Krishnamurthy’s spirited views on how the proposed merger of PSU banks be handled (The Hindu, 24th September 2019 - Makingthe grand Indian PSB mergers work) seems akin to a typical response in banks where loan appraisal notes are prepared after the decision to sanction a loan has been made so as to ensure smooth and hassle free disbursement without leaving any trace of the indiscretions on those who have to implement the decision!

It also raises some interesting questions.

First, does the merger move demonstrate the lackadaisical approach of policy planners? There is a one word answer to that. NO, in capital letters without any spelling mistakes. Irrespective of persuasion or ideology it is always in the interest of the ruling political class to keep control of the key financial intermediaries firmly in their hands. In India this has ensured, on one hand control over sanction of freebies in the form of cheap & directed credit and loan waivers to key players (read that as local politicians and strong-men) in the mass market which in turn enables them to get the votes in required numbers to win elections. On the other hand, it has helped steady and assured funding to key businessmen and industrialists who in turn finance and grease the political machinery. Merging the PSU banks by reducing the numbers would enable easier control on both sides of this game. It is as simple as that! This is also the main reason why some of the key recommendations over the decades have been blissfully ignored. Such as disbanding of Department of Banking (Narasimham I), more care in selecting top executives (Nayak – short-listing was opaque and typical interviews were virtually a shame), or the continued operations of BBB in selecting top executives from the same jaded cohort and no progress in recruitment of competent and professional for Bank Boards.

Second, was the key concern about announcing the merger lack of clear articulation of the rationale behind bringing disparate and weak banks together or the desperate need to announce some mighty sounding changes so as to dampen the effects of other disturbing information about the economy? Is it just a coincidence that the merger was announced about 1 hour after the latest GDP numbers were announced?

Third, as far as efficiency gains or improvements are concerned, why does all discussion get stuck only at the high NPA levels? Net profits in banks is arrived at by first deducting operating costs and then provisions from net interest margin. Staff costs of PSU banks as a percentage of Operating Costs is 3 to 4 times that of their private sector counterparts. Now since staff in PSU banks are not on the average paid 3 to 4 times that of private sector banks (not even by a very long shot), it should be obvious that a major reason for the lower profitability is also on account of high staff costs on account of low staff productivity. The underlying reasons could be low morale, outdated and redundant operating procedures, low skill levels, over manning etc. Somehow this aspect, that proximate cause of low profitability in PSU banks is also due to low staff productivity, hardly finds mention in any discussion.

Fourth, the narrative does not explain the high NPA levels at par with PSU banks in many high-profile private sector banks (both existing and those who have become history) or some well-known and established foreign banks. Could there be some other underlying reasons such as an outdated conceptual framework or misplaced regulatory priorities under which banking is practiced in India which contribute to the regular occurrence of high NPA levels? A framework which is not challenged by the academic community but carefully nurtured by the regulator? For example, the artificial dichotomy between working capital finance from term debt (only going concerns can hope to service debt and for an entity to continue as a going concern, it requires both working capital as well as term finance), or the heavy reliance on security as the basis for most lending (depending on foreclosure of security as the prime means of recovery of debt would impose such high transaction costs that no financial intermediary can even hope to be viable), or failure to differentiate between equity and debt risk (where the asset portfolio contains both equity as well as debt risk with no clear demarcation between the two and the pricing is based wholly on debt risk) ensures that the portfolio is perpetually sub-optimally priced and lending operations would be ab initio non-viable and there would be a steady incidence of NPAs which no amount of window dressing (including indefinite postponement of implementation of the Indian Accounting Standards (IndAS) norms for banks) can hide. No amount of ministrations or efficiency gains can help convert this congenital defect.

Fifth, a suggestion which keeps recurring is the need to induct professionals, especially in risk management and technology areas, at market related remuneration levels. What seems to be forgotten is that monetary returns are far from being key drivers of any professional worth his salt. Good professionals also need a culture and working environment to live up to their potential and in the absence of which they either become white elephants or simply pack up and leave.

Sixth, without clarity on market niches which exist and may be fruitfully exploited, and the kind of products and skills required to exploit them, there can be no direction on the kind of training that is required or should be imparted. Without such clarify, there would continue to be extreme competition in narrow product market segments leaving vast sections of the society and economy outside the pale of formal financial intermediation – with its accompanying discontents. One example which should provide the proof – if a proof is required – is the extremely low levels of utilisation of humongous numbers of PMJDY accounts. And this is not because the potential for savings is absent in the Indian economy. Is it a wonder that Indian financial markets continue to be highly fragmented?

Seventh, related to the above is that if PSU banks are to be really efficient and effective they need to build the ability to strategize and develop skills in identifying and exploiting market niches.

Seventh, why should and to what extent could governments actively plan steps to offset a possible slow expansion in bank credit? Is that an acceptance of the unsaid fact that existing PSU top management are incompetent? Or that the patronal relationship carefully built up over the last five decades between bank management and their political masters has ensured that present day management are incapable or precluded from taking independent decision taking? Moreover, if the government has to involve itself in distangling ownership in JVs of  PSU banks, what are bank managements expected to do?

No amount of visionary leadership or rhetoric can replace a basic understanding of how financial markets operate, which is in no way helped by the fact that they have a mind of their own and operate in fairly counter-intuitive ways. And without that understanding any fiddling around in the policies and practices on operation of financial markets is nothing short of quackery. Research over the last half a century has helped clarifying very many aspects, but our policy makers and academics refuse to take cognizance. The irony is that a key aspect of this understanding was developed by an American economist working at the Indian Statistical Institute at Delhi!