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In fact: Lessons learnt — and not learnt — in India’s PSU banking

Even though Manmohan Singh had announced, in his famous Budget speech of 1991, to suggest reforms in the financial sector, it was only two years later that the government and RBI decided to implement the report in two stages.

Written by Shaji Vikraman |
Updated: April 5, 2017 6:08:56 pm

The first two years of the P V Narasimha Rao government were marked by attempts at repairing the economy through a combination of measures including industrial delicensing, encouraging foreign investment and exports, and controlling the fiscal deficit and double-digit inflation. By 1993, macroeconomic indicators were more stable — foreign exchange reserves had risen to $ 13 billion from the barely $ 1 billion when the government took over, current account deficit was low, and foreign direct investment and portfolio flows amounted to about $ 3 billion. In this situation, the government decided to move on to financial sector reforms. Even though Manmohan Singh had announced, in his famous Budget speech of 1991, a high-level committee headed by former RBI Governor and Economic Affairs Secretary, M Narasimham, to suggest reforms in the financial sector, it was only two years later that the government and RBI decided to implement the report in two stages.

The banking landscape then was dotted with state-owned banks, many of whom were in bad shape because of dodgy lending and management practices. As the new rules, based on global practices on income recognition, for setting aside funds for bad loans, kicked in, the burden of providing extra capital for banks fell on the government.


In 1993-94, the government set aside Rs 5,700 crore for bad loans and doubtful debts in the form of bonds to banks — a clever accounting way of preventing outgo of cash. Once it realised that the quantum of funds needed was over Rs 10,000 crore, however, it was decided to nudge the banks to tap public capital markets to raise fresh capital to ease the burden on the promoter — the government.

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It wasn’t easy. The Banking Companies Act did not provide for public listing, and given the emotions attached to state control of lenders, especially for the Congress party, the Finance Minister sounded out the RBI Governor, C Rangarajan, to get lawmakers on board. That meant talking to a lot of stakeholders, and convincing them of the merits of the move — though there were reports suggesting that the government was being forced by conditions attached to loans given by multilateral lenders. By the end of the year, it was done — even though the legislative changes came with the condition that the government’s shareholding would at no time fall below 51%.

While discussing the plan to raise capital, it was clear to policymakers that the option of divesting a good part of the holding would not work. That meant banks would have to raise fresh capital to boost lending. India’s largest bank, State Bank of India, tapped the capital markets in December 1993 and January 1994 to raise over Rs 2,200 crore through an equity and rights offering at a premium of Rs 90 per share, and over Rs 1,000 crore through bonds.

Like in the late 70s and early 80s, when there was a scramble for share sales of multinational companies, this issue too did extremely well. The largest IPO in the Indian capital markets of that period was sold effectively through the bank’s wide network of branches, leading to a dispersed shareholding, especially of retail investors. RBI staff were instructed by the management of the central bank to buy 200 shares each, as it was a shareholder of SBI.

This was the trigger for several other banks to tap the capital market the next fiscal, 1994-95, beginning with the Delhi-based Oriental Bank of Commerce, which raised Rs 387 crore, resulting in the government’s equity holding falling to little under 67%. A few other banks returned some capital to the government to protect their earnings per share or EPS, helped also during that period by a change in banking laws, which allowed for reduction of the paid-up capital of banks.

It is to the credit of that government that financial sector reforms followed the real sector, rather than going hand-in-hand or ahead like in some countries, which got into trouble because they got the sequencing wrong.

In retrospect, it is interesting that a minority government was able to carry out such an important legislative change. Decades later, successive governments floundered in attempts to amend the law on public ownership of banks — their public sector character — which has been often blamed for curtailing their autonomy and operational freedom. During the Vajpayee government, Finance Minister Yashwant Sinha piloted a Bill to lower the government’s holding to 33% in public sector banks, but it was subsequently dropped.

Comparing that period with now, India appears to be caught in a time warp. The health of state-owned banks is a major worry, forcing the government to pump in more capital — over Rs 12,000 crore at last count this year, and Rs 70,000 crore over four years — and make attempts at cleaning up the mess, a legacy, of course, of the previous UPA government. But it is fascinating to look back at what Manmohan Singh as Finance Minister said in his 1993-94 Budget while providing government funds for banks.

“This is the price we have to pay for having long tolerated management practices in the banks and types of lending which paid inadequate attention to portfolio quality,” he had said. “While undertaking such a large injection of capital into these banks, specific commitments will be required from each bank to ensure that their future management practices ensure a high level of portfolio quality so that earlier problems do not recur.”

Today, it just sounds so surreal.

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