The Finance Ministry’s unequivocal missive to 10 state-owned lenders to submit time-bound turnaround plans , or forsake any further capital infusion from the government, is a small yet timely step in the right direction. As the Reserve Bank of India had flagged in its last Financial Stability Report, risks to the banking sector remain worryingly “high”. The continuous deterioration in asset quality, especially at the public sector banks (PSBs), has led to low profitability and substantial value erosion to the principal shareholder — the government. As the RBI’s report pointed out, PSBs saw the proportion of their gross non-performing assets to total advances almost double in the 12 months through September 2016 to 11.8%. That the Ministry has identified 10 of these PSBs to administer a dose of tough love suggests they are the ones most in need of urgent corrective action. In fact, RBI Deputy Governor Viral Acharya told bankers in a speech last month that the problem of bad loans has come to such a pass that, “we simply don’t as a society have any excuse or moral liberty to let the banking sector wounds fester and result in amputation of healthier parts of the economy.” This is because commercial lenders have a central role in the economy, by serving to harness public savings and directing the flow of crucial credit to the most productive industrial and infrastructure sectors. And when PSBs, with their revolving-door top managements, have little incentive or accountability to redress the burgeoning imbalance in their balance sheets, it is time the largest shareholder delivers an ultimatum: shape up or be prepared to face the consequences.
That the Centre has chosen to include the employees’ unions in the proposed MoUs it intends to enter into with the lenders is also indicative of the seriousness with which it is approaching the resolution this time around. Staff, who have been a key element in the growth and development of the sector, have a vested interest in the health of PSBs; the risk of continued failure is closure and job losses. To be sure, the Centre has to work simultaneously in close concert with the banking regulator and the lenders themselves to structure appropriate mechanisms to enable the implementation of the turnaround plans, including resolution of the stressed assets. Also, as Mr. Acharya pointed out, the PSB managements would need to be empowered so that “haircuts [writedowns on the value of debt] taken by banks under a feasible plan would be required by government ruling as being acceptable by the vigilance authorities.” The stipulation of a three-year time limit for the implementation of the turnaround is also significant as Indian lenders have to meet Basel III capital regulations by March 31, 2019. There is therefore little time to lose, and the government and the banks have their work cut out if India is to avoid the spectre of weak banks having little incentive to lend, and economic activity affected for want of credit.