‘Instead of capitalising weak PSU banks, govt should back growth’

There’s a case for the Indian government to move away from capitalising weak public sector banks and instead capitalise growth, says Union Bank of India chairman and managing director MV Nair. In Hong Kong last week for the second anniversary of the opening bank’s first overseas branch, Nair sat down with DNA Money’s Venkatesan Vembu to discuss the impact of Basel 3 norms on Indian banks, the lessons learnt from the global financial crisis, and the effectiveness of the transition to a base rate regime. Excerpts:

What impact will Basel 3 norms have on Indian banks, which are generally thought to be well capitalised?
You’re right that Indian banks in general are absolutely okay on the key elements of Basel 3  norms on capitalisation. With respect to Tier 1 capital, the RBI requires 6%, whereas Indian banks are at 9.3%. Common equity is at 90%, and in that sense too we are well capitalised.

The second area of likely concern relates to risks that might arise from India’s fast pace of growth. The risk-weighted average growth of the Indian banking industry could be anywhere between 20% and 25%. The question arises: will we incrementally be able to support by way of capital? Compared to an economy that grows at, say 3% and a certain return on equity, here our return is going to be 20%. So, we need capital, and that is going to be one challenge for us in public sector banks.

We’re in active discussions with the government on this. The time-tested approach of government is to capitalise weak banks, and we’ve said we should shift from that position. Instead, we should look to capitalise growth. The government has to take call on that: if it is not politically acceptable for it to bring down government holdings in public sector banks below 51%, you have to capitalise growth. We had a discussion for about 6 to 8 months, and they’re okay with it. We’ve sold an idea to increase government holdings in all banks where they are below 55%; we’ve suggested that the holdings be increased to 58% or 60% by infusing capital - at the market rate (so minority shareholders don’t lose out). Once that happens, at the next level, as and when we need capital, we could go in for a rights issue, where the government can also invest, or we can dilute.

So, the entire question of capital adequacy is going to be addressed squarely.  But there are other areas — for instance, of risk management practice. Indian banks are at various stages of implementation. The Indian Banks’ Association engaged Ernst & Young to conduct a test-check on all banks, and the RBI is also moving very systematically on this. Basel 2 compliance has been almost completed, and they’ve now asked banks to voluntarily submit themselves to credit risk assessment and market risk.

They may give us the all-clear signal, or ask us to improve our practices. So, by and large, we will be advancing systematically towards compliance.

But aren’t there enormous cost implications for banks?
Yes, the cost implications are huge! If you look at public sector banks, our data was in manufal form; most banks digitised them by 2008. But we need to capture seven years’ data, which is a huge task. But having said, that I believe that if you’re going to be around for 100 years, it’s better to get your systems in place. So, yes, there is a cost, but it’s worthwhile.

How do you justify asking the government for additional capital infusion in banks, considering the larger fiscal picture and the competing demand for capital resources?
It is a major question, which is why it took about 8 to 9 months. The government may tap the World Bank for funds for this purpose. The choice for the government is clear: how politically saleable is the proposition to reduce government holdings to below 51% - and how saleable is the idea of capitalisation? As of now the choice is for the second option.

It has been reinforced, particularly after the global financial crisis, that public sector banks have played their role well, and we do need them around. That being the case, at this point in time, the question is to agree to capitalise. Down the line, after say five years, people may forget what happened.

What lessons did the Indian banking industry learn from the global financial crisis?
It’s not that Indian banks have done something remarkably different, and much of the credit should go to the RBI. Secondly, the Indian banking sector substantially stuck to the core of banking. Banking practice as it evolved in India, and the regulators’ focus, has been unwavering. Public sector banks have always been much maligned, but what this financial crisis taught us is that a large country like India needs a diverse banking structure, where each one has a role, and it’s unfair to denigrate anyone. Our banking structure is fairly unique: we have private sector banks, public sector banks, foreign banks, regional rural banks, and cooperative banks. It’s good to have this diverse structure.

When the crisis unfolded in 2008, we realised that the issue was quite serious; the government then came out with a package. We suddenly saw credit lines choked across the globe, and we too were affected. We saw some foreign banks withdrawing from India because their parents told them to.

Over the next eight months, it was the public sector banks that kept the liquidity alive. Every fortnight, along with the government, we held a video conference to monitor the loan sanctions made by public sector banks. Over these eight months sanctions were 150% higher than during the previous year. Of course, not all sanctions went into utilisation. But the very fact that sanctions were available was a great confidence creator.

Similarly, when the mutual fund industry came under strain—following redemptions—the RBI gave a credit line for public sector banks, which we made available to the mutual fund industry. Similarly with NBFCs. It was the timely provision of liquidity that helped overcome the problem. All this was a great learning experience.

Union Bank has an ambitious plan for its global operations, and so too do other Indian banks. When you go abroad, do you embrace greater risk, and what risk mitigation practices do you follow?
After we opened our first overseas branch—in Hong Kong—we went slow because we wanted to study how we should operate in a global scenario, and since we didn’t’ want take any risks. But it’s time for us to slowly accelerate. By 2012 Union Bank is looking to have 10 full-fledged overseas branches and subsidiaries, and our overseas portfolio should be about $3 billion by 2012. By 2020, our global operations should account for at least 20% of our business.

But our banking practices will by and large remain what they are in India, except to customise them to local requirements. We will primarily be supporting Indian corporate and Indian ethnic communities overseas. Over a period of time, with experience, we may get localised, but we’re not in a hurry. What drives our global ambition is the fact that there is an acceptance for India as a brand globally, and there are a large number of Indians moving out.

Considering the demographic profile of India and of advanced economies, the requirement for younger workers will have to be supplied by India. If we don’t plan now, we may miss out on that piece of action.

How has the transition from a BPLR regime to a base rate regime worked for Indian banks?
It has worked well. We initially had a lot of apprehensions: the industry was used to sub-BPLR, and it was a big change. The RBI’s had concerns that the transmission of interest rates should take place smoothly.  The way it is structured, we have keep the BPLR and base rate on two tracks going for another 25-30 years, because some loans are for 20-25 years.  It is very easy for corporate office to arrive at what the base rate is, but at the implementation level, it is very confusing, and we wanted to overcome it.

Right now it is working fine, but we want to avoid confusion after 2-3 years, when people start forgetting what BPLR is about. We have to see as we move on. We will revisit our base rate in the next quarter; the good thing is that you revisit it every quarter, and to that extent transmission of policy is possible.

There was much apprehension that the RBI was behind the curve on fighting inflation. What are your thoughts?
Given the circumstances that we were operating in— and the need to maintain balance between growth and inflation—the RBI had to take the call. It obviously didn’t want to impact growth while countering inflation.

But if you look at the elements of inflation in India, it is drive by supply-side constraints, and there is no point in the RBI going ahead with an action and then impacting growth. In my personal view, the RBI took the right call at the right time.