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Tuesday, October 20, 2020

Rajan, Acharya proposals for the banking sector: Winding down of DFS, reprivatising select PSBs

On tackling of bad loans, they said private asset management and national asset management “bad banks” should be encouraged in parallel to the online platform for distressed loan sales.

By: ENS Economic Bureau | Mumbai | Updated: September 22, 2020 10:23:03 am
On tackling of bad loans, they said private asset management and national asset management “bad banks” should be encouraged in parallel to the online platform for distressed loan sales. (File)

Former Reserve Bank of India (RBI) Governor Raghuram Rajan and former Deputy Governor Viral Acharya have proposed creation of a bad bank, winding down of Department of Financial Services in the Ministry of Finance, paring down the government stake in public-sector banks (PSBs) below 50 per cent and reprivatisation of some PSBs to reform the banking sector.

In a paper titled “Indian banks: A time to reform?”, released on Monday, Rajan and Acharya said state-linked banks can be a first step in altering the ownership structure of some PSBs, where the government brings down its stakes to below 50 per cent, creating distance from operations of banks and improving governance along the way. “Re-privatization of select PSBs can then be undertaken as part of a carefully calibrated strategy, bringing in private investors who have both financial expertise as well as technological expertise; corporate houses must be kept from acquiring significant stakes, given their natural conflicts of interest,” they said.

The paper said automatic dilutions can be deployed as another intermediate step to reprivatisation, whereby the government commits upfront to letting the bank board dilute the government’s stake through raising of fresh capital whenever the government is unable to inject the capital required to meet regulatory requirements.

The paper said winding down Department of Financial Services in the Ministry of Finance is essential, both as an affirmative signal of the intent to grant bank boards and management independence and as a commitment not to engage in “mission creep” when compulsions arise to use banks for serving costly social or political objectives. While Rajan is now Professor of Finance at University of Chicago Booth School of Business, Acharya is Professor of Economics at the NYU Stern School of Business.

On tackling of bad loans, they said private asset management and national asset management “bad banks” should be encouraged in parallel to the online platform for distressed loan sales. Private players could aggregate and recover on loans in sectors where government intervention isn’t necessary. “The national public sector “bad bank” could serve as a vehicle to aggregate loans, create management teams for distressed firms, and possibly buy and hold distressed assets in a sector, like power, till demand returns. It could provide fall-back prices for loans sold by PSBs,” the paper said.

They said incentive structures for managements need to be strengthened with longer terms for senior management, better assessment of performance, performance-based promotions and extensions, as well as some reliance on lateral hiring, which would also bring in state-of-the-art banking ideas and practices.

“Operational independence for boards and management … needs to be embraced by creating a holding company structure for government stakes,” they said.

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