Dual Control In Public Sector Banks: Need For A Reform Rather Than Privatisation

Anurag Singh and Aniketa Jain are fifth year students at National Law University, Jodhpur.

Recently, there has been discussion going on regarding the poor performance of Public Sector Banks (‘PSBs’) and a rise in Non-Performing Assets (‘NPA’). One of the reasons attributed to the poor performance of PSBs was the governance of these PSBs i.e., dual control by the Ministry of Finance under the Central Government and the Reserve Bank of India (‘RBI’). Central Government is planning to privatise all the PSBs soon with the listing of Life Insurance Corporation the central government plans to privatise Industrial Development Bank of India as a move to control the increase in NPAs and improve corporate governance in these PSBs with Central Bank of India and Indian Overseas Bank next on the radar.

In his speech, Urjit Patel (Former Governor of RBI) during his visit in 2018 at Gujarat National Law University, Gandhinagar talked about the problem of dual control. He elaborated on how the dual regulation of PSBs by the RBI and Ministry of Finance is damaging their performance and governance structure. By way of this article, the authors have first discussed the current situation of PSBs and the problems related to dual control, and second, why privatisation is not the solution to this problem. In conclusion, the authors have provided a suggestion to deal with the problem in governance of PSBs.

A. Current situation of PSBs and the problems related to dual control

a) Rising NPAs in PSBs

i. A key factor contributing to the rise in NPAs was the loosening of lending standards for corporations. Their finances and credit were not carefully checked. PSBs accepted more risk for less promoter equity. Many of the outstanding loans went to companies with a low interest coverage ratio. Banks sold unsecured loans to be competitive, leading to large NPAs.

ii. The lending industry has played a significant role in the rise of NPAs. Agriculture, education, housing, and Micro, Small, and Medium Enterprises (MSMEs) are all priority sectors. In Tamil Nadu, educational loan NPAs increased to 16.3% as of March 2021 from 15% at the end of March 2020.

b) Provisional instances of imbalance of power between the RBI and the government

Imbalance in the powers of RBI and the government can be observed in the provisions of the Banking Regulation Act, 1949 (‘BR Act’). Since PSBs are not covered by Section 36ACA(1) of the BR Act, RBI is unable to remove directors and members of the management at PSBs. The Bank Board supersession provision in Section 36ACA(1) of the BR Act does not apply to PSBs (or regional rural banks, or RRBs) because they are not banking firms established under the Companies Act. PSBs are not covered by Section 10B(6) of the BR Act, which calls for the resignation of the Chairman and Managing Director (‘MD’) of a banking business. According to Section 45 of the BR Act, the RBI cannot compel a merger in the case of PSBs. Therefore, RBI cannot withdraw a licence under Section 22(4) of the BR Act as it can, in the case of, private sector banks because PSB's banking activity does not require a licence from RBI under Section 21 of the BR Act. In accordance with Section 39 of the BR Act, RBI cannot cause the liquidation of PSBs. Additionally, in some instances, the MD and the Chairman have the same title, which is a unique exception that suggests the MD largely answers to themselves. Thus, as can be seen, there is a significant imbalance in the powers granted to the RBI and the government under the BR Act.

c) The use of public banks to implement socialist welfare measures

Changes should be made to the Central government’s debt management policies, including off-budget borrowings. These initiatives have damaged the Centre’s budgetary credibility. The government has pressured public banks to give farmers low-cost loans without collateral. The government has waived loans through these public banks, which has impacted the national treasury and budget. The central government channels its fiscal policy through public sector banks by issuing unsustainable levels of credit and then recapitalizing them when necessary, resulting in fiscal expenditure.

B. Privatisation: Boon or Bane?

The government has proposed to alter the Banking Companies Acquisition and Transfer Acts of 1970 and 1980, as well as the Banking Regulation Act of 1949, to privatise two PSBs and satisfy the finance minister's disinvestment targets set out in the Union Budget 2021-22. Since these laws resulted in nationalisation of banks, they must be amended to allow for privatisation. As a result of these changes, the minimum government ownership in PSBs will be decreased from 51 % to 26 %. In the previous session, the government had passed the General Insurance Business (Nationalisation) Amendment Bill, 2021, which allows state-owned general insurance companies to be privatised. However, the government has ignored the following issues related to privatisation:

• Due to the dominance of PSBs over rural access, rural banking will hinder privatisation. PSBs have branches nationwide and in practically every district, while commercial banks are limited to more developed or inhabited areas. Commercial banks would struggle to match the power and reach of PSBs. If private banks take over rural branches of PSBs, it will be difficult to control and maintain them, and to gain the rural population's trust. People in India trust government organisations, whether they are PSUs or PSBs. Due to privatisation, people's trust might drop, reducing deposits in newly privatised banks.

• According to the privatisation proposal, private sector banks would not be subject to dual-channel oversight by the Ministry of Finance and the RBI, as is the situation for public sector banks. The restricted application of Right to Information (‘RTI’) and the exclusion of private banks from external vigilance enforcement by the Central Vigilance Commission (‘CVC’) and Central Bureau of Investigation (‘CBI’) would have a detrimental effect from the standpoint of depositors.

• PSBs have the greatest advantage over commercial private banks since they are backed by the government. Due to government backing, they are not susceptible to extinction or full failure. There is always hope for revival. The most recent instance is the restructuring of the Punjab National Bank, in which government intervention was sought by way of debt recovery and restructuring of the bank's assets, following the failure of the PNB due to frauds, scams, and its inability to generate sufficient cash flows to stay afloat.

C. Recommendation:

The reliance on government oversight over RBI regulation on these PSBs has led to poor performance and bad governance. Therefore, the best plausible solution to deal with the issue of rising NPA in PSBs is not to privatise these banks but to provide RBI with complete autonomy to deal with the PSBs.

The reliance on government oversight over RBI regulation on these PSBs has led to poor performance and bad governance. Further, as recommended by the PJ Nayak Committee Report of 2014, (‘Committee’) which discussed dual regulation of PSBs, all government regulatory tasks should be transferred to the RBI immediately, relieving PSBs from dual regulation. Moreover, limiting development tasks to PSBs is discriminatory. It further provided that the government should avoid issuing regulatory instructions only for PSBs because it is discriminatory. The RBI should oversee all commercial banks and enforce consistent regulations.

RBI has been equipped with requisite power and skill to deal with the governance of PSBs. The Reserve Bank of India Act, 1934 (‘RBI Act’) established India’s central bank and outlined its tasks, board makeup, director terms, and government control. A group of experts viewed the government's threat to use Section 7 as invading on the central bank’s land. A reading of the law, however, gives the government the legal power. Clause 1 of Section 7 states, “The Central Government may provide the Bank such orders as it deems suitable in the public interest.” “Subject to such directions, the general supervision and management of the Bank's activities and business shall be committed to a Central Board of Directors,” the next clause adds.

Even when the RBI has the power to penalise, it is rendered useless as these sections do not apply to PSBs constituted under Section 3 of the Banking Companies (Acquisition and Transfer of Undertakings) Act, 1970, or regional rural banks, or a banking company.

Sections 46 and 47A of the BR Act, 1949 allows the RBI to penalise officials for wilfully making a false statement in the balance sheet (up to three years in prison or a fine of INR one crore, or both) and knowingly making a false statement in a balance sheet (up to three years in prison or a fine of INR one crore, or both).

Section 30 of the RBI Act allows the government to replace the Central Board if RBI “fails to carry out any of its obligations” The administration must then submit a complete report to Parliament within six months on the circumstances and action taken.

D. Conclusion:

The Banks Board Bureau should reduce the RBI's conflict of interest as a bank regulator and supervisor. As regulator and supervisor, the RBI should be ownership-neutral. Private banks are profit-driven. Private banks are oriented to make profits and serve promoters' interests, as YES Bank shows. Since private banks want profits, PSBs' welfare state model may suffer. PSBs offer low-cost services, subsidised depositor accounts, and other government programmes for the welfare state. At the behest of a shifting political environment, PSBs cancel and wipe off debt for marginalised persons.

Private banks may charge hefty service fees to offset operational costs and expenses. They may also cause disparities in loan approvals and interest rates between the rich and the poor, resulting in unequal wealth distribution. Bringing PSBs under the banking sectoral regulator RBI and allowing it to regulate their activities autonomously is the solution to rising NPAs.