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New Delhi: The Narendra Modi government’s reform of public sector banks over the past six years is a “stillborn effort,” said a new research paper co-authored by former Reserve Bank of India (RBI) deputy governor Viral Acharya. and former RBI Governor Raghuram Rajan.
The duo suggested a series of reforms, including greater operational independence for state banks, gradually reducing the government’s stake below 50 percent and reprivatizing some select banks to begin with, in the document released Sept. 21. and available on the University website. from the Chicago Booth School of Business.
The newspaper warned that the pandemic will dramatically increase credit losses in the system and may be more than the government can afford.
“With government deficit and debt levels reaching enormous levels, there are simply not enough budget resources to recapitalize the banks. An undercapitalized and encumbered public sector banking system will not lend well, which will be a huge tax on growth, as it has been for the past six years, ”the newspaper said.
“More worryingly, without reform the banks will accumulate more losses. The status quo is simply not an option, ”he added.
The authors also stressed that for banking to become an engine of growth, incremental reforms are not enough.
“With the enormous strains on government finances from slow pre-COVID growth and the subsequent effects of the pandemic, the country has to transform the banking sector from being a drain on government resources and an impediment to growth to becoming an engine growth. This will not happen through gradual reforms. The status quo is fiscally unsustainable, ”the newspaper said.
Acharya was deputy governor of the RBI from 2017 to 2019. He resigned before completing his term in July last year. Rajan headed the central bank between 2013 and 2016.
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‘Little incentive to loosen grip’
The document noted that despite Prime Minister Narendra Modi’s backing of reforms in state banks, including the appointment of the Bureau of the Board of Banks to decide key appointments, there has been little progress in recent years.
“The final decision, as well as the assignment of selected CEOs to the banks, still rests with the government. The Department of Financial Services still appoints the members of the bank’s board and decides important strategies such as mergers, ”the newspaper noted.
He added that it is unfair to blame only the bureaucracy, as the government in power has “little incentive to loosen its grip on public sector banks.”
Former central bankers pointed out that the government gains enormous power by directing bank loans, including the power to exercise control over industrialists.
Citing the example of electoral bonds, the document noted that the government gains access to sensitive information through its state property, as well as the identity of the electoral bond buyers, which is known only to the State Bank of India.
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More independence for banks, abolishing financial services Department
Acharya and Rajan’s paper suggested various measures to improve the performance of state banks, but noted that many of them have been taken by committees such as the Narasimham and PJ Nayak panels.
He called for improving the operating performance of state banks through a holding company structure for government banks. He added that the government should pay state banks for costs incurred to meet their goals, such as opening branches in remote rural areas.
The document also suggested eliminating the Department of Financial Services (DFS). DFS is one of the five departments of the Ministry of Finance that oversee state banks.
He also advocated for incentives for top management and longer terms for bank heads.
State-linked and non-state banks
The document recommended gradually reducing the government’s stake in public sector banks, starting with reducing the stake below 50 percent.
He added that the reprivatization of certain PSBs can be studied along with the automatic dilution of government holdings.
“Our proposals, taken together, will move the needle significantly in Indian banking. However, they are not revolutionary … There are strong interests against change, which is why many would-be reformers are cynical … We are more optimistic that a middle way can be achieved, given that the greatest obstacle has been the government, the bureaucracy, and the interests within it. “
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