Indian Government Should Cut Stakes in Banks, RBI Panel Says

India’s government should cut its stakes in state-controlled banks to below 50 percent, a central bank-appointed committee said in a set of recommendations to improve competitiveness and governance. Ownership in private-sector lenders should be allowed to rise, the panel also said.

The committee recommended that the Reserve Bank of India act as sole regulator for the state banks, and government holdings in the lenders be transferred to a new bank investment company, according to a 111-page report posted on the RBI’s website yesterday.

Shares of the government banks, which have underperformed private-sector rivals in the past five years, surged today amid optimism the proposals will help revive state lenders’ profits. The banks have lost “significant” market share and their asset quality is “much weaker, in some cases worsening to grave proportions,” according to the report.

“Investors will go overweight on state-run banks if these recommendations are implemented,” Vishal Narnolia, a Mumbai-based banking analyst at SMC Global Securities Ltd., said by phone. “These proposals can help state-run banks to tide over the capital constraints and will turn them into entities focused on making profits rather than trying to serve the public at the cost of shareholders.”

The CNX PSU Bank Index of state-controlled banks jumped 3 percent, headed for its highest close in almost a year, as of 1:44 p.m. in Mumbai, while the S&P BSE Bankex Index of mainly private-sector lenders added 0.2 percent. Including dividends, the PSU index returned 83 percent to investors in the five years through yesterday, compared with the Bankex’s 146 percent.

Shares Rally

Eleven of the PSU index’s 12 lenders climbed at least 4 percent today, led by Bank of Baroda’s 8.4 percent surge. The lender, based in the state of Gujarat, was poised for its highest close in more than three years and was the MSCI Emerging Markets Index’s best performer today. Canara Bank Ltd. rose 7.6 percent, while Bank of India gained 6.6 percent.

“The central government is a good example of a bank shareholder that has suffered deeply negative returns over decades,” the panel said. “It is in the government’s own interest to improve governance and management.”

State-controlled lenders, which account for more than 70 percent of India’s outstanding loans, have historically been under-capitalized relative to privately owned peers as a 51 percent government ownership requirement curbs the scope those banks’ have to raise capital by selling shares. This in turn limits their capability to boost lending, or requires the government to inject cash into the banks.

Panel Recommendations

Reducing government ownership below 50 percent would be beneficial because the government would continue to be the dominant shareholder in its banks and such a step “would create the conditions for its banks to compete more successfully,” the report said.

“It is a fundamental irony that presently the government disadvantages the very banks it has invested in,” the committee said in its report, which covers 27 state-controlled lenders. The panel was led by P. Jayendra Nayak, a former chief executive of Axis Bank Ltd. and former India country head for Morgan Stanley.

The RBI, led by Governor Raghuram Rajan, invited comments on the panel’s recommendations by June 12, according to a statement from the central bank yesterday. Spokeswoman Alpana Killawala wasn’t immediately available to comment today.

This isn’t the first committee appointed by the central bank to make bold proposals. In January, an RBI panel recommended the central bank adopt a 4 percent consumer-price-inflation target in setting interest rates.

Bad Loans

One goal of the changes the Nayak committee proposed is to avoid the “repeated claims” for government capital injections that the state-controlled banks now make, according to the report.

The outgoing government of Prime Minister Manmohan Singh pledged to inject 112 billion rupees ($1.8 billion) into state-controlled lenders in the fiscal year that started April 1, a 20 percent drop from the previous year.

Bad loans have climbed to a six-year high as red tape stalled projects amid delays in acquiring land, obtaining environmental clearances and graft allegations. Soured advances rose to 4.2 percent on Sept. 30 from 3.4 percent in March, RBI data show.

Regarding private-sector banks, the panel proposed that a category of Authorized Bank Investors be created that would be able to own as much as a 20 percent stake in a private-sector bank without regulatory approval.

Private Equity

ABIs would include entities such as pension funds, long-short hedge funds, exchange-traded funds and private-equity funds. Excluded would be proprietary funds, non-banking finance companies and insurance companies.

“Allowing larger block shareholders generally enhances governance,” the committee said.

For banks identified as distressed by the RBI, private-equity funds, including sovereign wealth funds, should be permitted to take a controlling stake of as much as 40 percent, the committee proposed.

Proportionate voting rights should be introduced to align investors’ power in shareholder meetings with the size of their stake, it said.

When the RBI determines there has been “evergreening” of assets at a bank, it should be authorized to claw back bonuses to executives and directors and also to cancel unvested stock options.

Election Results

“The report makes some fairly good suggestions to improve governance and tackles long-pending issues like the whole range of public-sector bank ownership and appointment of boards,” said Shinjini Kumar, a Mumbai-based director at PricewaterhouseCoopers. The RBI and India’s next government will have to decide how to proceed with the proposals, she said.

Indian general elections concluded May 12 and results will be announced May 16. Exit polls signal that the main opposition Bharatiya Janata Party, led by prime ministerial candidate Narendra Modi, won a majority and will end the 10-year administration of the Congress party.

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