A paper co-authored by former RBI Governor Raghuram Rajan and former RBI Deputy Governor Viral Acharya also calls for winding up of the Department of Financial Services.

Former RBI governor Raghuram Rajan while giving a speech
Money Banking Tuesday, September 22, 2020 - 10:38

Former RBI Governor Raghuram Rajan has highlighted the "still-born effort to reform public sector banks" and "the failure of the Gyan Sangam", a conclave held on the banking sector in 2015.

These points have been brought forth by Rajan in a paper co-authored with former RBI Deputy Governor Viral Acharya, who had resigned from his post.

While giving a number of suggestions on banking reforms in the paper, including winding up of the Department of Financial Services in the Finance Ministry and reducing government stake below 50 per cent, Rajan said many of these have been discussed in the past which concern public sector banks and their governance.

"Is there any reason to be more confident that they will be implemented now," Rajan asked.

"One salutary warning should be the NDA government's still-born effort to reform public sector banks," Rajan and Acharya said in the paper.

Following the PJ Nayak Committee report of 2014, the government brought a variety of key players together to the Gyan Sangam in early 2015, which recommended the setting up of a Bank Board Bureau to make public sector bank appointments, and the creation of strong empowered bank boards that would allow banks to have differentiated strategies.

One complaint heard there was that every public sector bank branch looked similar, no matter which bank it belonged to and no matter where it was located.

"These ideas were supported by the Prime Minister," the paper said.

Prime Minister Narendra Modi had presided over the conclave while Rajan was the RBI Governor then.

"Yet five years later, it appears that little has changed. The government still appoints bank CEOs; instead of the earlier practice of appointing a nomination committee dominated by government bureaucrats and regulators (with a couple of academics and retired bankers to ensure an outside opinion), that same committee is lodged within the Bank Board Bureau," the paper said.

"The final decision as well as allocation of selected CEOs to banks is still with the government. The Department of Financial Services still appoints bank board members and decides on important strategies such as mergers," it added.

"The failure of the Gyan Sangam suggests that any change has to have steady political support (rather than a one-off ceremony) and will have to be forced on a bureaucracy, notably the Department of Financial Services in the Finance Ministry, that has little incentive to change. Yet it is probably unfair to blame just the bureaucracy -- the government in power has little incentive to loosen its grip on public sector banks. Why," Rajan and Acharya asked.

The paper argues that the government obtains enormous power from directing bank lending. "Sometimes this power is exercised to advance public goals such as financial inclusion or infrastructure finance, sometimes it is used to offer patronage to, or exercise control over, industrialists," it said.

"The government also has potential access to an enormous amount of sensitive information through its state ownership. For instance, the identity of purchasers of electoral bonds is known only to the State Bank of India," the paper said.

"The government can oblige party members by appointing favourites to positions in public sector banks, including on their boards, and once there, some of these appointees use their influence to direct bank loans to favoured parties.

"Parliamentarians of all parties are not immune to the lure of public sector banks, the banks are often asked to arrange the logistics for their fact-finding committee meetings in enjoyable locales across the country. And Finance Ministry bureaucrats are reluctant to let go of the power that allows a young joint secretary to order the chairpersons of national banks around," the paper noted.

Change is necessary, and perhaps it may be forced by the pandemic, Rajan and Acharya argued.

The costs of the system, as reflected in the huge loan losses it generates, may soon be greater than what the government can afford to pay. With government deficits and debt levels reaching enormous levels, there are simply not enough budgetary resources to recapitalise banks, they said.

"An encumbered, under-capitalised public sector banking system will not lend well, which will be a huge tax on growth, as it has been for the last six years. More worrisome, without reform the banks will cumulate further losses," the paper said.

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