Lack of freedom is an attribute that fits in very well in public sector banks' operational aspects

The recent downgrade of State Bank of India by Moody's Investor Service has evoked strong reactions from the markets and policymakers. While predictably the stock markets tanked, a section of the policymakers and bankers has questioned the credentials of the agencies and the rating process.

On October 4, Moody's — one of the big three rating agencies, Standard & Poor's and Fitch Ratings being the other rating agencies — reduced its rating on SBI's financial strength (basically credit worthiness) from C minus to D plus amidst concerns over deteriorating asset quality and adequacy of capital. This has been a season of downgrades. Moody's especially has been on a downgrading spree — a number of banks on either side of the Atlantic have been downgraded. That SBI is just one of the several banks facing the downgrade is no consolation however.

The problems that banks in the advanced countries face are vastly different from what banks such as SBI experience. Almost all of them are reeling under the euro-debt crisis. Many of them had contributed to the global financial crisis through their reckless lending and underwriting practices, especially in the sub-prime home loan mortgage segment.

In contrast, SBI and other banks in India weathered the crisis admirably backed as they were by some enlightened regulation. Whatever the problems SBI is facing now they are certainly not due to past recklessness. Yet, in a rising interest rate scenario and economic slowdown, the quality of its assets has come under strain. The bank has had to make large provisions in the first quarter of the year. That has strained its capital adequacy norm. The Tier-I capital ratio of SBI at 7.6 per cent as on June 30, 2011, is now below the 8 per cent that the government has committed to maintain for public sector banks.

Onus on government

The onus has been on the government, which owns slightly less than 60 per cent stake of SBI. For almost a year now, the bank has been contemplating a Rs.23,000-crore rights issue. If the proposal had materialised, the bank would have easily met the required capital adequacy standards. The snag was that the government, the majority shareholder, was not in a position to take up its rights. At the same time, with a legal commitment to maintain a majority shareholding, the government cannot even contemplate renouncing its shares.

After the downgrade, reports speak of a scaled down rights issue — of about Rs.5,000 crore — a fourth of what was first proposed is planned for December. The government need to invest considerably less but will this limited exercise solve the problem of the bank? Over the short-term, SBI would be able to meet the capital adequacy norm. Despite that, as Moody's pointed out, “SBI's efforts to secure this capital for the better part of the year demonstrates the bank's limited ability to manage its capital…given that a bank's ability to freely access the capital markets is an important rating criterion globally.'' Hence, the downgrade was justified. Looking ahead, Moody's feels that SBI will run into capital constraints soon.

Ownership issue

In other words, SBI is not its own master even in matters as important as raising capital. A lot depends on the government, which brings into focus the much larger issue of government ownership of commercial banks. Is the government ownership of banks a help or a hindrance? After the recent downgrade, SBI's rating is below that of some of the new private banks such as HDFC Bank and ICICI Bank. That is highly unfortunate and to a large extent misleading. SBI has suffered not because of its balance sheet weakness per se, but because its majority owner, the government, is not in a position to contribute to its share in the enhanced capital that is necessary to shore up its balance sheet. Some private sector banks too are facing the problem of rising NPAs in a rising interest rate environment.

The difference is that they have much more flexibility than SBI in raising capital. It needs no special mention that SBI as well as most other public sector banks can tap all the capital they want, both within India and abroad, if only they have the freedom.

In fact the lack of freedom is an attribute that fits in very well in their operational aspects too. Much has been said about the constraints public sector banks work under and those essentially arise out of government ownership. There is, of course, a favourable side to government ownership. In times of crisis, public ownership can instil confidence.

Two examples from India are: Indian Bank and the Unit Trust of India. Their depositors and other stakeholders remained loyal to these institutions. There was no panic or run even though the problems of these were widely publicised. At the global level, the largest banks were saved from ruin during the financial crisis by government intervention which included a large infusion of capital in many cases.

Again it will be the government action, including recapitalisation that may save many iconic banks in the advanced countries reeling under the euro-debt crisis.