The way forward for PSU banks

Business Standard, 1 May 2018

PSU banks are demoralised. They fear the CBI, CVC, CAG and CIC. They are short of equity capital. Their corporate credit business is beset with problems. In this article, we offer strategies for the big questions. What should PSU banks do with borrowers who have defaulted? How should they make corporate credit decisions, going forward?

Bank privatisation is not the answer, today

In the long run, India should privatise the PSU banks. But this will not happen anytime soon. A large private banking system has a pre-requisite: State capacity in banking regulation. The one thing worse than a PSU bank is a poorly regulated private bank. When policy makers embark on building RBI, this is a project that will take five to ten years assuming good capabilities at MOF and at RBI. Until that project is completed, PSU bank privatisation is not advisable, even if it were politically feasible.

Three things to keep in mind

Three things need to be kept in mind when we look at our predicament.

  1. While PSU banks face a shortfall in equity capital, they are backed by the government. There have been no runs on PSU banks; customers trust PSU banks as much as they trust the Government of India. PSU banks get a vast subsidy -- cheap debt from consumers -- as a consequence of this trust. This gives time and room to maneuver.
  2. The organisational capabilities of PSU banks are highly heterogeneous. SBI is a well run bank that is better than most private banks. And, there are truly badly run PSU banks. The total assets to market capitalisation ratio, which is a market-based leverage ratio, ranges from 12 times for SBI to 71 times for Corporation Bank or United Bank of India. We need to keep this heterogeneity in mind when envisioning solutions.
  3. While there is a lot of focus upon the outstanding corporate credit by PSU banks, this overall number is shaped by a flow of repayments that come in and a flow of new credit that goes out. Decisions are being made about new disbursements all the time. The corporate credit business of PSU banks should not freeze up to the point where no new credit decisions are made. A quarter of listed non-financial firms are in distress with an interest cover ratio of 1.5, but the top quarter of listed non-financial firms are in great shape with an interest cover ratio of 13. PSU banks should be happy to lend to firms where objective accounting data shows good health.

Strategy for PSU banks

Let us now turn to the big questions that demand action. What to do with borrowers who have defaulted? What to do with borrowers who have not defaulted? How to make credit decisions, going forward?

The borrower has defaulted. With borrowers who have defaulted, the lender needs to make the right moves in the Committee of Creditors that is formed through the IBC immediately after the default. PSU banks are hobbled by fears of enforcement agencies and often have poor internal management procedures. For example, in one recent case, the representative of a PSU bank voted in favour of a resolution plan at the Committee of Creditors, but later on the organisation reneged on this decision. This derailed the timelines of the IBC process.

The solution lies in detailed work on modifying CVC, CBI and CAG procedures so as to support sound processes at a capable PSU bank. The solution for a PSU bank with low capabilities is to sell off defaulted loans, through an open auction. This will also require removing the special status of ARCs, so that any financial investor is able to bid for these assets on an equal footing. A very wide pool of private equity funds, distressed asset funds, etc. should be in the fray competing for buying these bonds/loans. This will improve the value realisation for PSU banks, compared with the tiny pool of capital with ARCs.

A borrower that has not yet defaulted. What would work for PSU banks is to hold the better loans and sell off the weaker ones. This should be done through a low-discretion mechanism. Rules should be established, based on accounting data about firms, through which borrowers are classified into strong vs. weak. The basic idea is simple: weak firms have high leverage and low profitability, with cutoffs that vary based on the capabilities of the bank.

There is a long tradition of thorough and objective credit analysis, based on accounting data, at the best PSU banks. RBI and MOF can support this process by giving greater legitimacy to good process designs, as has been done through many expert committees in the past. The hard thing for DFS and RBI will be to differentiate between banks that have high organisational capabilities and those that do not.

How should PSU banks give out incremental gross credit? A low-discretion mechanism needs to be evolved, where facts about borrowing firms are used to give loans to stronger firms. When the borrower drops below a certain threshold, the PSU banks should sell off the loan.

Conclusion

PSU banks will be around for a while. We have to make them work better. They find it hard to make decisions based on judgement and discretion. A more formulaic approach will work better for them, and this has actually been part of the organisational DNA of the best PSU banks in the past. PSU banks should utilise objective facts from the accounting data about borrowers to classify borrowers into high vs. low credit risk. PSU banks with low organisational capabilities should exit the corporate credit business for high risk borrowers.

The business of giving credit to weak borrowers, and participation in the IBC process, is one that is feasible for sound PSU banks, and for non-bank players. We should create non-discretionary rules through which these weak borrowers are identified. We should remove the special status of ARCs, and create a large unified pool of private funds which own bonds or loans to weak firms, and dominate the IBC process.

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