Confidence in the working of public sector banks is at a historically low level, said former RBI governor YV Reddy in a speech in Kolhapur on Saturday while outlining a host of reasons behind the perceived crisis in the banking sector. Reddy advised policy makers to offer clarity on the objective of public ownership of banks and lay down a roadmap for these entities.
There are six sources of discomfort that have led to doubts about trust in banks in recent months, according to Reddy. These include:
- Mounting non performing assets due to defaults by the “very rich and very powerful.”
- Inadequate capital to make up for non performing assets
- Proposal to make depositors share the burden of insolvency (via depositor bail-ins)
- Large criminal frauds detected in select banks
- Investigations launched and raids conducted into some CEOs and board members
- Impression that RBI is taking severe actions
Detailing his perspective on the NPA problem, Reddy provided data to show that NPAs are not at historic highs. Gross NPAs in 1996-96 stood at above 15 percent of advances. At present Gross NPAs are at 11.2 percent of total advances.
Bad loans impact depositors when banks don’t have enough money to pay them, that is, when capital is not adequate, Reddy explained.
At present, while private banks have enough capital to meet depositor obligations, public sector banks do not, Reddy said
“...there is inadequate capital with public sector banks to meet the obligations of the banks to the depositors. However, it is not a problem for the safety of deposits because the owner is government.”
In any case, the tax payer has to pay for high NPAs since the Government as the owner of these banks has to bear the burden, Reddy added.
Another factor that had caused discomfort is the proposal to bail-in depositor funds in the case of insolvency of a bank. Reddy suggested that putting the proposal on hold is the right thing to do. “Yet the proposal has itself created a panic, and some withdrawal of deposits took place. To an extent, some permanent damage has been done to the trust in safety of bank deposits,” he added.
Bank Frauds And Investigation
Referring to the spate of investigations into the conduct of bankers, Reddy said the “magnitude of the actions in recent months is unprecedented”.
Whether the raids and investigations will end up punishing the “really guilty” and act as a deterrent remains to be seen, he said. “But, what is certain is that there is loss of confidence in the integrity of the banking system.”
Referring to the Rs 14,000 crore fraud at PNB, Reddy said that the government, which is the owner of the bank, stands to lose the most. The owner should be worried about the systems, the conduct of the managers and should also ask what its nominated directors on the board were doing.
Eventually it is the tax payers who will pay for the losses. “The tax payers who have entrusted their money to the government-owned banks should be asking the government to explain why as the custodian of their money it failed to prevent the fraud.”
The RBI, too, cannot escape responsibility. The fraud is of such a magnitude that it affects the credibility of RBI in ensuring the trust of people in banking, Reddy said. “To this extent, it has to review its own regulatory and supervisory practices.”
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The Road Ahead
Reddy advised policy makers to put out a vision statement laying out a roadmap that is “non-disruptive.” Along with taking punitive action, systems should also be fixed to avoid a repeat of past mistakes, said Reddy.
He added that there should be clarity on the future of public sector banks. “The objective for public ownership of banks should be clarified and simplistic comparisons with the private sector banks avoided.” He also batted for strengthening of urban cooperative banks and allowing them to expand.
The effectiveness of RBI should also be enhanced with demonstrable support from the Government, Reddy said.
“Finally, confidence, coherence, consistency and clarity should be maintained in official pronouncement on banking recognising that banks are special and deposits in banks are very special.”