Indradhanush – Plan for Revamp of Public Sector Banks


Ajit Kumar AJIT KUMARWISDOM IAS, New Delhi.

In August 2015 Department of Financial Services (Ministry of Finance) launched a plan for revamp of Public Sector Banks (PSBs) named ‘Indradhanush’.

Why Revamp of PSBs Needed?

The Public Sector Banks (PSBs) play a vital role in India’s economy.  Banking reforms in India is needed because resilient banking sector is a sine qua non for a strong economy. A Country’s capacity to the internal as well as external shocks depends largely on maintaining a robust banking infrastructure.  Banking sector has so long been strategic for supporting India’ service sector led growth. However, as the country plans to shift its gear to create a robust manufacturing base to augment job creation and exports, the role of banks has become all the more critical.

The Indian banking sector after independence was insulated from the global economy due to the policies followed by the government during 1960’s to 1980’s. These policies later contributed into Balance of Payment crisis of 1991 and hence the reforms were undertaken. Since, then Indian economy has grown with leaps and bounds and so has its banking sector. In 1998 an expert committee was set up under the chairmanship of M Narsimahan with the task of properly laying down recommendations for `the Indian banking sector and its regulation thereof. The suggestions by Narsimahan committee were breakthrough and the most

Nonetheless, post-2007 Public Sector Banks did face problems. These were instigated by many factors, like the sinking of economy even after surviving the recession. The other reason for worry was inflation, which stressed the monetary situation further. Part of the mayhem was contributed by bureaucratic delays like permit delay for land acquisition that directly stalled many big projects concerning infrastructure. This affected the banks credit negatively, led due to increased defaults of loans, mounting NPA’s and lowering of gross profitability of the PSB’s.
 
Capital Adequacy Capital or credit profile defines the success of bank. It highlights the strength of the bank to withstand shocks and failures. Credit Risk means that a bank’s borrower or customer is unable or shows unwillingness to meet its obligation towards the bank especially in relation to lending, trading and other transactions. For a bank this inability or unwillingness on part of the other party would accrue as a loss on its portfolio. 

The issue was addressed globally through the Basel Accord. These norms were passed after various round of deliberation between the countries. Basel I norms came into being in 1988 and talked about provisions regarding minimum capital requirement and risk weighted assets for banks. The major role of these norms has been to standardize banking practice across nations. Due to a few shortcomings in definition of earlier norms, Basel II were adopted which further laid guidelines for capital adequacy, disclosure requirements and risk management etc.

Despite these measures, the US Subprime Financial Crisis of 2008 brought to fore the deficiencies of financial regulation in Basel II norms. The norms allowed banks to take on certain other kind of risks that resulted into financial meltdown. Subsequently the Basel III norms were adopted in 2010. They create a voluntary global framework and were adopted to strengthen bank capital requirements, market risk etc. the implementation of these has been extended to March 31, 2019
 
Salient Features of Indradhanush

Considering all the above issues alongside recommendation of multiple committees important being Narsimhan (1998), Nayak (2014) Committee, measures have been taken by the government including the launch of Indradhanush.  ‘Indradhanush’ stands for seven areas mainly, Appointment, Bank Board Bureau, Capitalization, De-stressing PSB, Empowerment, Framework of Accountability and Governance Reforms. 
 
A) Appointments:

The Government decided to separate the post of Chairman and Managing Director by prescribing that in the subsequent vacancies to be filled up the CEO will get the designation of MD & CEO and there would be another person who would be appointed as non-Executive Chairman of PSBs. This approach is based on global best practices and as per the guidelines in the Companies Act to ensure appropriate checks and balances. The selection process for both these positions has been transparent and meritocratic. The entire process of selection for MD & CEO was revamped. Private sector candidates were also allowed to apply for the position of MD & CEO of the five top banks i.e. Punjab National Bank, Bank of Baroda, Bank of India, IDBI Bank and Canara Bank. Three stage screening was done for the MD’s position culminating into final interview by three different panels.
The process of selection of Non-official / Independent Directors has been revamped and made transparent.

B) Bank Board Bureau:

The announcement of the Bank Board Bureau (BBB) was made in Budget 2015-16. The BBB will be a body of eminent professionals and officials, which will replace the Appointments Board for appointment of Whole-time Directors as well as non-Executive Chairman of PSBs. They will also constantly engage with the Board of Directors of all the PSBs to formulate appropriate strategies for their growth and development. The structure of the BBB is going to be as follows; the BBB will comprise of a Chairman and six more members of which three will be officials and three experts (of which two would necessarily be from the banking sector). The Search Committee for members of the BBB would comprise of the Governor, RBI and Secretary (FS) and Secretary (DoPT) as members. The BBB would broadly follow the selection methodology as approved in relevant ACC guidelines.
 
C) Capitalization:

As of now, the PSBs are adequately capitalized and meeting all the Basel III and RBI norms. However, the Government of India wants to adequately capitalize all the banks to keep a safe buffer over and above the minimum norms of Basel III.
Government, therefore, estimated how much capital will be required this year and in the next three years till FY 2019. Out of the total requirement, the Government of India proposes to make available Rs.70,000 crores out of budgetary allocations for four years as per the figures given below:
(i) Financial Year 2015 -16 - Rs. 25,000 crore
(ii) Financial Year 2016-17 - Rs. 25,000 crore
(iii) Financial Year 2017-18 - Rs. 10,000 crore
 (iv) Financial Year 2018-19 - Rs. 10,000 crore
    Total - Rs. 70,000 crore
 
It may be  estimated that PSB’s market valuations would improve significantly due to (i) far-reaching governance reforms; (ii) tight NPA management and risk controls; (iii) significant operating improvements; and (iv) capital allocation from the government. Improved valuations coupled with value unlocking from non-core assets as well as improvements in capital productivity, will enable PSBs to raise the remaining Rs. 1,10,000 crore from the market.

Moreover, the government is committed to making extra budgetary provisions in FY 18 and FY 19, to ensure that PSBs remain adequately capitalized to support economic growth.

The manner of allotting Rs.25,000 crore capital in 2015-16, as announced earlier, is as follows:

 Tranche 1: About 40% of this amount will be given to those banks which require support, and every single PSB will be brought to the level of at least 7.5% by Financial Year 2016.

Tranche 2: 40% capital will be allocated to the top six big banks viz. SBI, BOB, BOI, PNB, Canara Bank, and IDBI Bank in order to strengthen them to play a vital role in the economy.

Tranche 3 The remaining portion of 20% will be allocated to the banks based on their performance during the three quarters in the current year judged on the basis of certain performance. This will incentivize them to improve their performance in the current year. Eight banks which did not get any money in first two tranche will get preference.

(D) (a) De-stressing PSBs

The infrastructure sector and core sector have been the major recipient of PSBs’ funding during the past decades.  But due to several factors, projects are increasingly stalled/stressed thus leading to NPA burden on banks.  In a recent review, problems causing stress in the power, steel and road sectors were examined.  It was observed that the major reasons affecting these projects were delay in obtaining permits / approvals from various governmental and regulatory agencies, and land acquisition, delaying Commercial Operation Date (COD); lack of availability of fuel, both coal and gas; cancellation of coal blocks; closure of Iron Ore mines affecting project viability; lack of transmission capacity; limited off-take of power by Discoms given their reducing purchasing capacity; funding gap faced by limited capacity of promoters to raise additional equity and reluctance on part of banks to increase their exposure given the high leverage ratio; inability of banks to restructure projects even when found viable due to regulatory constraints.  In case of steel sector the prevailing market conditions, viz. global over-capacity coupled with reduction in demand led to substantial reduction in global prices, and softening in domestic prices added to the woes.

(D)( b) Strengthening Risk Control measures and NPA Disclosures

Besides the recovery efforts under the DRT & SARFASI mechanism the following additional steps have been taken to address the issue of NPAs:

(i)  RBI has released guidelines dated 30 January, 2014 for “Early Recognition of Financial Distress, Prompt Steps for Resolution and Fair Recovery for Lenders: Framework for Revitalizing Distressed Assets in the Economy” suggesting various steps for quicker recognition and resolution of stressed assets:

(a) Creation of a Central Repository of Information on Large Credits (CRILC) by RBI to collect, store, and disseminate credit data to banks on credit exposures of Rs. 5 crore and above,

(b) Formation of Joint Lenders Forum (JLF), Corrective Action Plan (CAP), and sale of assets. 

The Framework outlines formation of JLF and corrective action plan that will incentivise early identification of problem cases, timely restructuring of accounts which are considered to be viable, and taking prompt steps by banks for recovery or sale of unviable accounts.

(ii)  Flexible Structuring of Loan Term Project Loans to Infrastructure and Core Industries – RBI issued guidelines on July 15, 2014 and December 15, 2014 –

 Long term financing for infrastructure has been a major constraint in encouraging larger private sector participation in this sector. On the asset side, banks will be encouraged to extend long term loans to infrastructure sector with flexible structuring to absorb potential adverse contingencies, (also known as the 5/25 structure).

(iii) Wilful Default/Non-Cooperative Borrowers:

RBI has now came out with new category of borrower called Non-Cooperative borrower.  A non-cooperative borrower is a borrower who does not provide information on its finances to the banks. Banks will have to do higher provisioning if they give fresh loan to such a borrower.
Fresh exposure to a borrower reported as non-cooperative will necessitate higher provisioning. Banks/FIs are required to make higher provisioning as applicable to substandard assets in respect of new loans sanctioned to such borrowers as also new loans sanctioned to any other company that has on its board of directors any of the whole time directors/promoters of a non-cooperative borrowing company or any firm in which such a non-cooperative borrower is in charge of management of the affairs.

(iv) Asset Reconstruction Companies:

Taking further steps in the area, RBI has tightened the norms for Asset Reconstruction Companies (ARCs), vide guidelines dated August 5, 2014, where the minimum investment in Security Receipts should be 15% which was earlier 5%. This step will increase the cash stake of ARCs in the assets purchased by them. Further, by having more cash up front, the banks will have better incentive to clean their balance sheet.

(v) Establishment of six New DRTs:

Government has decided to establish six new Debt Recovery Tribunals (DRT) (at Chandigarh, Bengaluru, Ernakulum, Dehradun, Siliguri, Hyderabad) to speed up the recovery of bad loans of the banking sector

(E) Empowerment:

The Government has issued a circular that there will be no interference from Government and Banks are encouraged to take their decision independently keeping the commercial interest of the organisation in mind. A cleaner distinction between interference and intervention has been made. With autonomy comes accountability, accordingly Banks have been asked to build robust Grievances Redressal Mechanism for customers as well as staff so that concerns of the affected are addressed effectively in time bound manner.
The Government intends to provide greater flexibility in hiring manpower to Banks. The Government is committed to provide required professionals as NoDs to the Board so that well-informed and well-discussed decisions are taken.

(F) Framework of Accountability:

(a) The present system for the measurement of bank’s performance was a system called SoI – Statement of Intent.  Based on certain criteria decided by Ministry of Finance, the banks used to come up with their annual target figures which was discussed between the Ministry and banks and finalized.  The entire exercise took very long and sometimes the targets for banks used to be finalized only towards the end of the year which is not a desirable thing to do.  There are two changes we are making in this:

(i) A new framework of Key Performance Indicators (KPIs) to be measured for performance of PSBs is being announced.  It is divided into four sections totaling up to 100 marks.  25 marks each are allotted to indicators relating to efficiency of capital use and diversification of business/processes and 15 marks each are allotted for specific indicators under the category of NPA management and financial inclusion.  The total marks to be allotted for quantifiable, measurable criteria is 80. 

(ii) The remaining 20 marks are reserved for measurement of qualitative criteria which includes strategic initiatives taken to improve asset quality, efforts made to conserve capitalHR initiatives andimprovement in external credit rating.  The qualitative performance would be assessed based on a presentation to be made by banks to a committee chaired by Secretary, Department of Financial Services.

The new framework for KPIs is in the docket (Agenda).

Operating performance evaluated through the KPI framework will be linked to the performance bonus to be paid to the MD & CEOs of banks by the Government.  The quantum of performance bonus is also proposed to be revised shortly to make it more attractive.  We are also considering ESOPs for top management of PSBs

(b)  DFS has issued a circular to PSBs laying down strict timelines for filing of complaints of fraud cases with CBI as well as for monitoring each and every case almost on a day-to-day basis. 
(c) Streamlining vigilance process for quick action for major frauds including connivance of staff. RBI has issued guidelines in May, 2015 to streamline the framework for dealing with the loan frauds. Under the new guidelines, a timeframe of six months, red flagging of accounts, constitution of a Risk Management Group (RMG) in banks to monitor pre-sanction and disbursement, nodal officer for filing complaints with CBI, provisioning in four quarters and creation of Central Fraud Registry have been laid down. Department of Financial Services (DFS) has directed PSBs to make CVO as the nodal officer for fraud exceeding Rs 50 crore, in consortium lending the lead bank will file the FIR for all banks and CBI has designated one officer for reviewing and monitoring progress of bank’s fraud cases.

(G) Governance Reforms:

The process of governance reforms started with “Gyan Sangam” - a conclave of PSBs and FIs organized at the beginning of 2015 in Pune which was attended by all stake-holders including Prime Minister, Finance Minister, MoS (Finance), Governor, RBI and CMDs of all PSBs and FIs.  There was focus group discussion on six different topics which resulted in specific decisions on optimizing capital, digitizing processes, strengthening risk management, improving managerial performance and financial inclusion.  The decision to set up a Bank Board Bureau which was subsequently announced in the Budget Speech of Hon’ble Finance Minister, came out of the recommendations of Gyan Sangam.  Also, at this conclave, Hon’ble Prime Minister made a significant promise to the bankers that there would be no interference from any Government functionary in the matter of their commercial decisions.  


Thursday, 03rd Mar 2016, 08:07:07 AM

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