By Disha Rawal
A minuscule percentage of the Indian populace pays income tax. The rest of the country feeds on the services paid for by these very people. This majority comprises of both the richest and the poorest sections of the society. Given this low resource base, one would expect high utilisation efficiency on part of the government. So, when ?11,000 crore are fraudulently extracted from public entities, there are immense explicit and implicit losses to the system. First, banks lose their ability to extend credit, nipping multiplier effects in the bud. Consequently, the eroding public faith in the state would reduce either its incentive to work or the tax that people pay.
Thus, a problem of this scale has more importance than what it seems like at the face value and warrants a deeper solution. In this case, it has been continuously said that a major issue with Indian banking is the dearth of reform of the public sector banks. However, despite repeated attempts at reform, little seems to have changed with time.
Audit methods
When a string of banking crises hit the US, like the Enron scandal, it immediately aroused the need to create an overarching independent body. This body was called the Public Company Accounting Oversight Board (PCAOB). This increased the level of trust the stakeholders assume in audit processes since it replaced the self-regulated system that was prevalent in the US at that point. India needs its own corresponding body in the form of National Financial Reporting Authority (NFRA), and that should ideally be a member of the International Forum of Independent Audit Regulators (IFIAR). IFIAR is an international body of independent auditors and has members from 52 countries. In the meantime, the government needs to quickly act to create a body exclusively for listed companies under the SEBI.
However, internal systems must be robust as well to ensure independent and effective audit procedures. The problem, however, is that PSBs do not enjoy the autonomy needed to hire the right kind of talent for their organisations.
Talent management
It is widely known that in public sector banks, the senior staff is paid much less than the staff at the same superiority level as in banks, while the junior staff is paid much better. This may reduce the incentive that the staff has to work. PSBs need to hire talent that is comfortable with using data-heavy, technologically advanced methods of due diligence before lending money. However, the public sector banks are not empowered to hire autonomously and locally, since appointments happen through competitive exams, and lateral entry has not proven to be a particularly successful arrangement. The boards of PSU Banks are weak entities with little authority. Boards neither appoint the CEO or the executive directors nor do they have the authority to set targets and manage performance.
Thus, an important part of this reform is to grant autonomy to public banks to hire talent best suited to them and prevent homogenisation of public banks across the country.
Homogenisation of banks
Since PSBs rarely take any autonomous decisions, they have failed to differentiate amongst themselves and have no competitive edge in the market. All PSBs are catering to similar sectors, and this has led to high systematic risk in the bank system. This is especially problematic since India faces the major issue of financial inclusion, and banks can diversify along the lines of scale, size, and spread to cater to historically disadvantaged regions too.
Debate about recapitalisation
There is currently a lot of emphasis on recapitalising banks, and the government has rolled out packages for this purpose. However, recapitalisation was supposed to be conditional on the performance of banks, and the due diligence to be done before extending credit. Many public sector banks did not match these requirements. Regardless, the money given to PSBs by the government in the past two years has been exceptionally high.
Banks are supposed to fulfil a lot of obligations. Moreover, they face influential political pressures and thus, end up giving some bad loans over the years. This is the bargain that the government makes with the PSBs, which reduces the competitiveness of the entire sector. If we can break these political links and institutionalise banking processes, perhaps there would be sunnier days ahead.
Featured Image Source: Flickr