On The Road To Nowhere

Both shareholders and employees are stakeholders in the well-being of a company. But their interests can often be divergent. And this time, caught between these divergent interests was finance minister Yashwant Sinha, who was bound to displease one of the two sides. But on November 16, when the cabinet decided to reduce the government's holding in public sector banks, barring the State Bank of India (sbi) and its subsidiaries, to 33 per cent (without diluting control), Sinha and the rest of the cabinet managed to displease both sides and achieve nothing.

If anything, this was a decision that has come to typify this government: don't take the hard decisions when faced with any political opposition. According to the decision, while the government is willing to reduce its stake in public sector banks to 33 per cent, no other shareholder will be allowed to buy more than 1 per cent of a bank. The government shall also continue to appoint bank chairmen, executive directors and directors on their boards. "This is a half measure which doesn't change things much," says Rohit Kumar, head, credit risk practice, at icra Advisory Services. The very next day, the All-India Bank Employees' Association (aibea) said they would go on indefinite strike (which will bring banking across the country to a virtual halt) when the bill to introduce changes in the Banking Companies (Acquisitions and Transfer of Undertakings) Act is introduced in Parliament this winter session. Says aibea assistant general secretary Kamal Bhattacharyya: "The main objective of this decision is to change the character of public sector banks." And though public sector bank stocks rallied initially, they came tumbling down—to their already poor valuations—soon after.

Just why did the government take this decision and how have they managed to spoil things for everyone? To ensure that Indian banks stay healthy, the Reserve Bank of India (rbi) mandates certain rules. One of them is that they must maintain a capital adequacy at least equal to 9 per cent of their risk-weighted assets. In other words, if a bank has lent Rs 100, it must have a capital base of at least Rs 9. And up to Rs 6 of this capital can be in the form of plain equity and free reserves, which is known as Tier 1 capital, while another 50 per cent of Tier 1, i.e. Rs 3, can be Tier 2 capital, made up of revaluation reserves and subordinated debt. To further increase safety of Indian banks, the rbi intends to increase capital adequacy to 10 per cent in the future. This is the level at which most good foreign banks operate. In fact, if the capital adequacy of a bank falls below 8 per cent, it is not allowed to perform correspondent banking operations and its Letters of Credit are not accepted internationally.

For banks to lend more, they have to increase their capital base. One way to to do so is by turning profits into reserves—but typically, Indian banks have a profit of only about 0.8 to 1 per cent of their assets. "The profit of public sector banks is not enough to generate the capital needed to sustain desirable growth levels," says Kumar. The only other way is to issue fresh equity. For this, the government—as the promoter of these banks—would need to cough up money to allow these banks to grow. The government has done this in the past. But these days, no one is more cash-starved than the finance ministry. And in any case, this is a never-ending cycle. Indian public sector banks have grown at 16 to 18 per cent over the last few years.To maintain this rate of growth, the central government would need to continuously infuse capital into these banks. And that's well nigh impossible.

The only option is to allow banks to offer their shares to the public. And that's been done in the past. Today, the government holds only 52.6 per cent of the Bank of India (BoI), 66.2 per cent of the Bank of Baroda (BoB) and 66.5 per cent of the Oriental Bank of Commerce (obc). All these banks meet their capital adequacy norms comfortably. As of March 31 this year, BoI's capital adequacy was 10.57 per cent, obc's figure stood at 12.72 per cent, and BoB had a capital adequacy of 12.10 per cent.

So, in the near future at least, none of these banks need to tap the capital markets to increase their capital base. With the result that they won't see a reduction in government stake below 51 per cent in the near term. But as they keep growing, they'll need to expand their capital base and issue fresh equity to the public. There'll be a time, therefore, when government stake will go below 51 per cent. That's irked the bank employees. "Bank nationalisation is an article of faith for us. Ultimately, the government's stake will go below 51 per cent," says Bhattacharyya. "But the government had no other option," counters Kumar: if public sector banks are to stay healthy, someone needs to invest the money.

On the other hand, the government's decision not to remove control has got shareholders equally agitated. "This decision of the government means that 67 per cent of the shareholders will have no say in how their bank is run," says Hemendra Hazari, investment analyst with securities firm, ask-Raymond James. "This will put minority shareholders at a disadvantage."

Most analysts believe that it is due to government control and the lack of accountability of bank boards that public sector stocks are quoting at a discount to their issue price. For instance, while Dena Bank raised money at Rs 30 a share in 1996, today it is traded at Rs 8.50-9. BoB raised money at Rs 85 the same year and today quotes at Rs 43-47. BoI's case is even worse. It raised money at Rs 45 in 1997 and today it quotes at Rs 11. "Shareholders haven't had a good experience with this sector," says Kumar.

One reason for this is the high level of non-performing assets (npas) in the Indian banking system. About 7.3 per cent of the banking sector's total assets, or Rs 54,000 crore, is locked up in npas. Internationally, good banks have npas of only 2 per cent. Most analysts believe that to an extent, these npas are a result of political interference in bank management. And it is due to political control of these banks that adequate measures aren't being taken to recover them. Therefore, the stockmarket believes that the only way the banking sector will get good valuations—and investors return for their money—is if the government relaxes control. But that's anathema to both the government and the employees.

The outcome of all this is that when these banks are forced to tap the markets, they will get poor valuations. Which means that the government will have to dilute a greater amount of its stake—than it would otherwise have—to raise money. Just ask Vijaya Bank, which is raising money at Rs 10 a share this week. Clearly, it's a situation that suits no one. But try explaining that to the government. Which will in any case face an uphill battle in Parliament, trying to pilot the amendments in the Banking Act.