Note: This article is follow-on to views penned on 4th and 12th September 2020 on evolvement of banking sector since 1994 and investors perspectives on way forward.
It’s sensible that NaMo 2.0 is focused on putting in place strong foundation ahead of building scale on the economic capacity with ambition of $5 Trillion GDP before 2024. Accordingly, the Government has pushed through reforms on social sector, agriculture, labour, while others on land, legal etc should be work in progress. To attract long term capital, there has been significant increase on FDI limits allowing majority foreign ownership in most sectors. It got easy when in command of majority in the lower house and support from like-minded regional parties in Rajya Sabha.
While lot’s being done on economic and monetary reforms, there’s lot to do in the banking sector that provides leverage to equity for capacity expansion. There’s strong bonding between GDP growth and performance of credit & non-SLR investments of the banking sector – direct and through shadow banks, the NBFC sector. The credit growth is estimated at 2-2.5X of GDP growth, which means that at 6% GDP growth, average credit growth rate of banking sector is at 12-15%.
Capital is scarce and big ticket sources are limited, hence the need to revisit promoter holding restrictions
Banks would need large dosage of capital for higher provisioning for Covid-19 impacted NPAs and to fuel growth engine in FY22. When time is of essence with less than six months to go for end of FY21, need to empower the banks with desired capital. While PSU banks are high dependent on the budgetary allocation, cash rich promoters of private banks don’t have the headroom to invest more than set upper limit of 15%, seeking for increase in “cap” to 25-40%? When ownership of Government in public sector banks is over 50% and licensing conditions for new generation private banks did stipulate the minimum holding of promoter at 40% to ensure that there’s more skin in the game over long term, RBI could consider limit enhancement from 15% to 26-40%.
Why the need for higher promoter holding relevant at this stage?
Government decision to sell majority stake of 7 (out of 12) PSU banks to private promoters would need offer of higher capital limit to get higher premium and entry of deep pocket entities. On the other side, having lost over 75% value from the peak and low investors appetite, it’s appropriate to give promoters the opportunity to bring in fresh capital beyond 15% to 26-40%, which will give confidence to regulators and other stakeholders that the promoters are indeed serious to ensure continuity & sustainability and keen to participate in lending for capacity expansion.
What’s relevant is establishing compliance & governance standards and not restrictions on capital structure
It’s good that the system has got the wake up call from bank failures from below par risk & compliance monitoring processes and inefficient governance standards. RBI is in the process of tightening regulatory supervision and Chinese-wall protection between promoters and management, avoiding conflict of interest and upgrade of board level supervision over risk & compliance keeping control functions outside the direct responsibility of the Chief Executive. It’s obvious that ensuring fool-proof compliance & governance standards mitigate risks from higher promoter holding while ensuring that interest of minority shareholders stay protected.
Cap of 40% holding by single/group ownership across public & private banks is good balance between governance & performance
Performance woes around public sector banks is largely attributed to dominant ownership by government while mishap in private banks is from failure of compliance & governance when the largest shareholder holding the reins of the management. When both the models have failed, it’s appropriate to think different approach with combination of single/group ownership cap to 40% and disconnecting the conflict of interest play between largest shareholder and the top management, avoiding double-hat with empowerment to the Board having good mix of Independent executive and non-executive directors. This model will lead to better monitoring jointly by hands-off promoters and eyes-in regulators.
It’s win–win advantage both for the system and stakeholders
It’s two-way advantage for the system as whole – flow of additional capital from promoters will increase the appetite of other institutional & retail investors to help banks recover the eroded value, thereby improving depressed sentiment of the banking sector. On the other hand, combination of higher CAR, leveraging higher share premium (for better EPS) will increase credit risk appetite of banks, which is need of the hour to pump debt capital into the system for capacity & credit expansion in FY22 & beyond. Combination of reinstatement of credit appetite and establishing fair value of banking sector is “two for one” reward for the system by providing the opportunity for those promoters that wish to put more monies at stake, seeking to enhance paid-up capital exposure from 15% to 26-40%.
Thinking aloud for the good of Indian economy & banking sector that needs to co-exist to establish economic prosperity and social wellness, and to provide catalyst push towards the ambition of becoming top-three economy of the world!
Moses Harding
