Govt must reduce stake in public sector banks to check on frauds

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Ganesh Prasad and Vishesh Arora

The Punjab National Bank-fraud to the tune of around Rs 12,600 crore involving the celebrity diamond merchant, Nirav Modi, has again brought to light the various issues plaguing the banking sector in India. The Nirav Modi case is not the first big ticket fraud involving the banking sector.

In recent years, India has witnessed various banking frauds, in fact, in 2017, a facsimile fraud involving Jatin Mehta’s Winsome Diamond Group was discovered. The total amount involved in the Winsome Diamond matter was around Rs 6,800 crore, out of which Punjab National Bank had the highest exposure of around Rs 1,800 crore.

The Ministry of Finance, in response to a question raised in the Lok Sabha a few weeks back, stated that during 2014-17, a total of 12,778 cases of fraud were reported in all scheduled commercial banks out of which 8,622 cases were reported by public sector banks (PSB). Further, in a recent statement made by Arvind Subramanian on the fraud committed by Nirav Modi, he advocated the need for privatisation of PSBs and stated that internal controls tend to be weaker due to government ownership.

In addition to such frauds, the PSBs are also dealing with the rising level of non-performing assets (NPAs) in their books. The Reserve Bank of India (RBI) in its bi-annual financial stability report has stated that the gross non-performing advances of the banking sector may rise from 10.2 percent of gross advances in September 2017 to 10.8 percent in March 2018 and further to 11.1 percent by September 2018.

A June 2017 report prepared by CARE Ratings on ‘NPAs in Banks’ mentions that State Bank of India (SBI) accounted for the largest share (22.7 percent) of the total NPAs during that quarter. The said report further mentions that the top 5 banks i.e. SBI, PNB, Bank of India, IDBI Bank and Bank of Baroda account for a share of 47.4 percent of the total NPAs and that 11 of the top 12 banks in terms of NPAs are with PSBs, with the exception being ICICI Bank.

The Government has time and again taken measures to improve the health of banking sector and control the rising rate of NPAs in the banking sector. Some of the latest measures undertaken include the implementation of the Insolvency and Bankruptcy Code, 2016 (IBC), and revised framework issued by RBI for resolution of stressed assets.

Despite these measures and other measures undertaken in past, the rising rate of NPAs in the banking sector is far from over. SBI, one of the country’s biggest banks reported a total loss of around Rs 2,416 crore for the quarter ending December 2017.

Governance and ownership

It is worthwhile to note that the report submitted by the PJ Nayak committee in 2014 on ‘Governance of Boards of Banks of India’ recommended that the Government should distance itself from several bank governance functions and a ‘Bank Investment Company’ should be constituted which will undertake the governance of banks and to whom the holdings of Government can be transferred.

The report further recommended that the Government should reduce its stake below 50 percent in PSBs in order to create conditions for PSBs to compete in a better manner.

The argument for privatisation of PSBs also takes support from the revelations of various other banking frauds in the aftermath of the fraud committed by Nirav Modi. Canara Bank recently reported a fraud involving extension of loans aggregating to $10.5 million to a company, further, a few weeks ago, the Oriental Bank of Commerce reported two separate frauds involving a loan fraud of about Rs 97.85 crore, and another fraud pertaining to a Delhi based jewellery outlet of about Rs 390 crore. The increasing rate of such frauds in PSBs is often attributed to the political influence exerted on them.

Implementation of the IBC was for many the last hope for confronting the existing NPA crisis. However, even upon enforcement of the Code, RBI had to step in and refer the names of 12 accounts (which represented around 25 percent of the gross NPAs) for proceedings under the IBC. It was only then that the financial creditors filed the applications for initiating the resolution process under the Code.

Such events involving massive bank frauds and rising level of NPAs in the banking sector, coupled with the fact that in the last 11 years the Government has already capitalised around Rs 2.60 lakh crore in PSBs, builds a strong argument for the Government to reduce its stake in PSBs.

The Government is repeatedly using the tax payers’ money to recapitalise the PSBs, however, no corresponding improvement is visible on the balance sheets of such PSBs. Even though it cannot be predicted whether privatisation of PSBs will result in completely solving the increasing number of bank fraud cases and the NPA crisis, however, at least the tax payers will not have to bear the burden of such losses.

It appears to be the right time for the Government to pass on the baton to private players by involving them directly in PSBs. In addition to increasing the involvement of private players, banks should also ensure that, an efficient system of checks and balances is maintained to guard against any frauds and errors, and, any loan that is extended basis the recommendation of a promoter or director of the concerned bank is recorded separately and reported to RBI from time to time.

This would hopefully bring in more accountability and corporate governance and restrict the increasing number of banking frauds and loan defaults.

(Ganesh Prasad is a Partner and Vishesh Arora is an Associate at Khaitan Co, an India-based law firm. Views are their personal.)