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Why bad loans aren’t govt banks’ only problem

The legacy of unplanned hiring in past decades, the dizzying pace of recent technological change, and the new, unprecedented competition threaten to reduce Indian government banks to zombies five years from now, says P Vaidyanathan Iyer.

Written by P Vaidyanathan Iyer |
Updated: February 18, 2016 1:40:51 am
Resolving issues that had stalled a plethora of projects in infrastructure sectors, ranging from coal and power to roads and ports, did not leave much time to attend to the crisis in banking. Resolving issues that had stalled a plethora of projects in infrastructure sectors, ranging from coal and power to roads and ports, did not leave much time to attend to the crisis in banking. (Illustration: C R Sasikumar)

Finance Minister Arun Jaitley said Sunday that a series of banking reforms would be announced in the days to come. He’d have done well to say this as soon as he took charge in May 2014. He and Prime Minister Narendra Modi knew quite well about the looming banking crisis. And that this affected public sector banks the most. People close to the new government swear this was a priority from day one. And yet, bank reforms disappeared from the agenda, and reappeared only when bad loans started contaminating the domestic environment. There may be many reasons — and the most plausible given by Modi’s top managers is the government’s preoccupation with the policy paralysis that the Congress-led UPA had left behind.

Resolving issues that had stalled a plethora of projects in infrastructure sectors, ranging from coal and power to roads and ports, did not leave much time to attend to the crisis in banking. Maybe Modi and Jaitley underestimated the time it would take to resolve such complex issues, with many landing up in courts. Maybe they overestimated their own ability to infuse confidence in the private sector so that the latter showed enterprise and began taking risks and investing. Or maybe they just lacked the conviction to bite the bullet.

What has happened in the meanwhile is for all to see. (The Indian Express published a series of reports on ‘The Great Govt Bank WriteOff’, of which the Supreme Court took suo motu cognizance on Tuesday.) A few days ago, Jaitley said that the non-performing assets (NPAs) or bad loans problem would soon come under control. But the high level of stressed assets — bad loans plus restructured loans — of public sector banks is not the only prism the Finance Minister should be looking through to understand the crisis. Yes, it is the most immediate and urgent aspect that needs attention. At 14.1% of total advances in September 2015, the stressed assets of public sector banks is significantly higher than private banks at 4.6%, and foreign banks at 3.4%. And public sector banks account for over two-thirds of advances by all scheduled commercial banks, providing an idea of what the numbers mean.

True, the government and the Reserve Bank of India will never let a bank fail. A booster dose of recapitalisation is required, and the government will certainly do that. It may also set up an asset reconstruction company, also called a ‘bad bank’, that will buy out the bad loans. The RBI will goad the banks to stop window dressing and reveal all bad loans. Governor Raghuram Rajan now believes band aid won’t help, and deep surgery is needed. He has given banks until March 2017 to clean up their books of accounts. But with his tenure ending this October, it is equally critical banks are not deprived of good post-operative treatment and care. While NPAs are the most pressing of problems, it won’t be easy for government banks any longer. An ageing workforce, poor technology grasp, intensifying competition, and the loading of costs and losses of populist government schemes on to public sector banks threaten to make zombies out of them.

Falling off the Cliff

A large number of employees will retire in the years up to 2020. The biggest challenge this “retirement decade” will present to banks will be the virtual absence of senior executives at crucial decision-making levels. After massive hiring from the 70s through the mid-80s, a recruitment freeze in the 90s has exposed banks to the “missing middle” problem. A 2013 McKinsey & Co survey of 20 government and public banks estimated that 87% of General Managers, 65% of Deputy General Managers and 50% of Assistant General Managers would retire in 2016-17. While the entry of private sector banks offering better compensation resulted in high attrition in state-owned banks, the inability to hire laterally at mid and senior positions, has left the government banks facing an HR crisis. Despite early warning, public sector banks and their owner, the government, have done precious little to stop themselves falling off the cliff.

Tech Illiteracy

New applications are being developed virtually every other day. Paytm, for example, the largest mobile wallet in the country, has about 120 million users — its transaction volume is larger than any bank. As of now, mobile bills, taxi fares and DTH recharges are some of the transactions you can undertake using Paytm. But the company, which is soon setting up a brick and mortar presence, could change the landscape of banking. Government banks, where the average employee age is over 40, are yet to fathom the disruption that technology is capable of inflicting. A few government banks are hiring professionals directly from campuses on contract, but most are just watching as companies like Paytm gain marketshare by tapping into cash-based transactions. Speaking on ‘Disruption in Financial Services’ at a TiE Leapfrog event, Infosys co-founder Nandan Nilekani said the financial sector was on the threshold of a “WhatsApp moment”, where a Ukranian migrant to the US with just 40 engineers changed the messaging scenario. WhatsApp now carries 30 billion messages a day, 50% more than the 20 billion that all telcos across the world put together carry. With a billion Aadhaars, a billion mobile phones and a billion bank accounts, Nilekani foresees a future where a smartphone will replace a credit card, and will be able to offer the two-stage authentication that a card does. As some of the best private banks grapple with such disruption, government banks remain miles away from putting together a tech strategy to even keep themselves relevant.

Intense Competition

For the last 45 years, government banks have conducted business in a benign environment. In July 1969, Indira Gandhi nationalised the country’s 14 largest commercial banks; another six were nationalised in 1980. Till 1993-94, no new banks were allowed. Ten banks then got licences — including HDFC Bank, ICICI Bank, UTI Bank (now Axis Bank), Global Trust Bank (merged with Oriental Bank of Commerce in 2004), IndusInd Bank, Times Bank (merged with HDFC Bank in 2000), Bank of Punjab (acquired by Centurion Bank, the merged entity being acquired by HDFC Bank) and IDBI Bank. In 2003-04, two more private banks, Yes Bank and Kotak Mahindra Bank, started. Last September, the RBI and government permitted 23 banks, two of which, IDFC and Bandhan, are universal banks. In six months’ time, government banks, already on their knees besieged by bad loans, will face the biggest storm of competition that they have seen in over 50 years.

Besides the two universal banks, the government banks will be exposed to an onslaught by 11 payment banks promoted by the likes of Vodafone, Airtel, Reliance, Mahindra and Aditya Birla, and another 10 small finance banks.

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