Bifurcate post of managing director and chairman for better governance in public sector banks: Raghuram Rajan

Raghuram Rajan, governor of Reserve Bank of India (RBI), has called for strengthening the government-run bank boards, attracting talent by reducing salary disparities with private sector peers and tackling the bad debt problem by having a bankruptcy code and giving more teeth to asset reconstruction companies. He acknowledged that the economy is a complex animal and India needs credible policies for growth and stability. In an interaction with the media a day after the monetary policy review was unveiled, Rajan also called for a change in the governance standards in public sector banks without necessarily changing the shareholding pattern.

The pile of bad debt for public sector banks is much higher than that of private banks. Lending norms are getting lax in government-run banks. What is going wrong?
In the last few years, health of the public sector banks has deteriorated. Bad loans and restructured assets are rising. Some of this is because of bad luck; they went into the infrastructure lending in a big way. When the environment changed the economy, the government processes changed. But some of it was also due to poor evaluation. Now PSU banks also suffer from hiring freezes in recent years, and they have a middle management gap and the talent pool coming up the ranks is limited. On top of that, bankers have decision making power over enormous assets even as their pay is limited. A lot of people are trustworthy and some deal with it like a public trust but some don't. Governance standards at PSU banks have to be on par with the best.

How can governance be improved?
Boards have to be beefed up by improving the board power. We have been recommending for bifurcating the CMD position -- the chairman who would be non-executive board member and a managing director who is the executive who oversees the operations. The finance ministry is a long distance from the bank and so you need a decentralised oversight process for it to work better. So strengthening the board is important. Managing directors should have longer tenures of three to five years. And finally, if you want the private sector talent to come into the public sector, the salary differentials should narrow. There is still some value in working with the public sector – the hire and fire system is less prevalent in the public sector. But it cannot be that the differentials are so large that it becomes difficult to attract talent. So we can expand the talent pool and reinvigorate the PSU banks.

What is the action the RBI taking against wilful defaulters?
We are working with Securities and Exchange Board of India in trying to ensure that wilful defaulters are prevented from accessing all kinds of funds. If somebody has damaged the system, by deliberately diverting funds, they should be cut off from accessing fresh funds from the public, be it from markets or banks. We are looking at some legislative changes on the powers of creditors in recovery for example what more names should be notified under the Sarfaesi Act. We are also trying to see if we can allow them to intervene earlier and perhaps get powers like those of banks, and we are trying to figure out our own definition of non-cooperative defaulters. We have this genre of promoters who holds up collection at every court using every instrument that they can even if the law suggest that they should pay. Our legal system permits various forms of hold up. That is completely legal but from perspective of the financial system, it could take years for recovery. Non-cooperative promoters are a financial risk. Though he may not be a criminal, he is using the laws to his advantage. We need a first rate bankruptcy code, there are versions in the companies act.

RBI was contemplating some operational guidelines for asset reconstruction companies (ARCs)?
We want ARCs to move more towards resolutions. Resolutions do not mean changing management but improving management recovery of the assets. We will have to examine that. We have upped the requirement skill in the game for ARCs. It becomes costly in participating in parking. Now the upfront investment of the ARC has been upped and it make it more difficult for a simple parking of assets for the ARCs and collect management fees for that. If we change some of the ARC powers which have to work with the government their ability to reconstruct assets would be stronger. We are open to new players entering the ARC business, taking over existing ARCs and recapitalising them. I understand that some foreign private equity firms are very interested in participating in India and we are open to hearing from them.

What is keeping the industry away from investing? Is it interest rates?
The industrial growth is beginning to pick up and I would very much doubt that it is the cost of capital that is the primary factor keeping back investments today. Of course, lower cost of capital would help. But even if we cut policy rates, we are not clear that banks will cut deposit rates until inflation rates come down. So to continuously say that the policy rate is the problem is missing the other constraints on investments.

How long can you sustain the fight against inflation?
Inflation is a disease we have to get rid of if we want a sustainable growth. Moderate inflation is fine, the high levels of inflation we had of close to 10% and above is detrimental in many ways. With high rates of inflation in order to keep people saving in fixed income you need high rates of interest. The real interest rates may not be very high because real interest rates are nominal minus interest.

What went wrong with the last few fights against inflation?
The problem in the last few fights against inflation has been that every time we looked like we are succeeding, the clamour rises that inflation is coming down and why don't we cut interest rates. We don't want to keep fighting inflation every two years which is what we have been trying to do in the last five-six years. Our point is 'let us try and reliably bring down inflation'.