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GS Paper: Indian Economy

  • Credit rating

    The Economic Survey-2020-21 highlights the issue of the adverse rating given to emerging economies by global credit rating agencies. This article suggests using our flawless repayment record as the basis of argument.

    Prejudice against emerging economies

    • The Economic Survey for 2020-21, charged international credit rating agencies with prejudice against emerging economies such as India and China.
    • The Survey has used economic size as an argument.
    • The economy that is the world’s fifth-largest has predominantly been rated AAA, S&P’s top rating.
    • By contrast, India, which displaced the UK in 2019 as the world’s fifth-largest, has been rated BBB-, the lowest investment grade.
    • The Survey points out that since 1994, only twice has the credit rating (as assigned by S&P and Moody’s) of the fifth-largest economy in US dollar terms been poor.
    • This was when China and India rose to that rank, in 2005 and 2019 respectively.

    Issues with Credit Rating

    •  Rating agencies rarely get credit quality right and they have been found to be well behind the curve in almost every default crisis.
    • The behavior of these agencies has been pro-cyclical, which is often seen to aggravate crises and fuel bubbles.
    • They are too lenient when the times are good, and too harsh when economic conditions worsen, making booms and busts that much more dramatic.

    What should be the basis of India’s argument

    • Unless the country has the privilege of printing the world’s reserve currency, as the US has, there is nothing special that ensures a large economy will always repay what it owes.
    • India’s argument should revolve around the country’s flawless repayment record.
    • The last time we were on the verge of a sovereign default, in 1991, we reformed our economy.
    • Today, the country has foreign exchange reserves in excess of $584 billion, while its total external debt, including that of the private sector, is a shade over $556 billion.

    Consider the question “The Economic Survey of 2020-21 point to the adverse rating of India economy by the global rating agencies. What is the significance of such ratings for the economy. What should be the basis of the argument against India’s adverse rating by the agencies?”

    Conclusion

    Despite the above-mentioned factors, we still find that Indian borrowers must pay higher rates of interest overseas than they would have to with a better rating. Global rating agencies need to overhaul their methodology to better reflect reality.

  • Keep the wheels of economic recovery turning

    Ahead of the Budget, the article discusses the status of Indian economy and suggests the measures to be adopted in the budget to speed up the recovery.

    Estimates of damages and signs of economic recovery

    • The first advance estimates of national income published on January 7 project a contraction of 7.7% for real GDP.
    • The Q2 GDP estimates published by the National Statistical Office had suggested an economic recovery in India.
    • An improvement in the rate of contraction from 23.9% in Q1 to 7.5% in Q2 was seen as the beginning of a sustained recovery.
    • The Ministry of Finance, in its Monthly Economic Review highlighted it as signifying a ‘V’ shaped recovery and as a reflection of the resilience and robustness of the Indian economy.
    • The Monetary Policy Statement of the Reserve Bank of India (RBI) released on December 4, 2020 also projects positive growth in the remaining quarters of the financial year.

    State of the economy before pandemic

    • Growth rate of the economy had collapsed from 8.2% in Q4 of 2017-18 to a mere 3.1% in Q4 of 2019-20, sliding continuously for eight quarters.
    • The policy stance against this backdrop was premised on the hope that private corporate investment will pick up momentum sooner than later.
    • The RBI did the heavy lifting through five consecutive lowering of repo rate along with liquidity infusion programmes.
    • However, monetary-fiscal linkages are crucial to catalyse the demand.

    Crucial role played by the RBI

    • While being cautious of inflation, the RBI has decided to continue the accommodative stance in its latest monetary policy to support growth.
    • The CPI inflation after crossing 7% has cooled off to 4.6% in December.
    • Still, the real interest rates remain very low.
    • The efficacy of the new monetary framework (NMF) — the agreement between the RBI and Government of India in February 2016 to adopt inflation targeting in India — will be reviewed in March 2021, and we flag the need for revising the framework.
    • The RBI is continuing its liquidity infusion programmes including the on-tap Targeted Long Term Repo Operations (TLTRO).
    • This programme announced on October 9, 2020 for five stressed sectors has been extended to 26 stressed sectors notified under the Emergency Credit Line Guarantee Scheme (ECLGS 2.0).
    • The RBI is also continuing its ‘operation twist’  with Open Market Operations (OMO) of ₹10,000 crore scheduled for December 17, 2020.
    • Nevertheless, the RBI Governor has rightly pointed out that the signs of recovery are far from being broad-based.

    Stimulus for targeted state intervention

    • According to the International Monetary Fund’s Fiscal Monitor Database of Country Fiscal Measures, the fiscal stimulus for India is 1.8% of GDP.
    • The IMF, in its Fiscal Monitor, highlights the need to scale up public investment to ensure successful reopening, boost growth and prepare economies for the future.
    • What we need is stimulus not based on “business cycle” but from the perspective of much needed targeted state interventions in public health, education, agriculture and physical infrastructure, and to redress widening inequalities.
    • As private final consumption expenditure is sluggish, contracting 26.7% and 11% in Q1 and Q2, respectively, a “fiscal dominance” is expected in India for sustained economic recovery.
    • However, India cannot afford fiscal stimulus at the rates of advanced economies, due to a lack of fiscal space.

    Way forward

    • Plummeting private corporate investment in India is a matter of concern.
    • The fear of financial crowding out emanating from high fiscal deficit is misplaced in the context of India.
    • Economic recovery will be determined by the degree of containment of the pandemic and the sustained macroeconomic policies.
    •  Any abrupt withdrawal of ongoing economic policy support, both by the monetary and fiscal authorities, will be detrimental to growth in times of the pandemic.
    • The fiscal rules at the national and subnational government levels need to be made flexible.

    Consider the question “Recovery of Indian economy battered by the pandemic has not been complete. Suggest the fiscal measure to be adopted by the government to speed up the recovery.”

    Conclusion

    The fiscal stimulus needs to continue in FY 2021-22 to speed up India’s recovery along with the measures suggested above.

  • The formidable challenge of reversing a liquidity glut

    The article highlights the challenge in dealing with the excess liquidity in the economy after the central banks injected liquidity by persuing unorthodox policies.

    Overview of policies adopted during 2008 financial crisis

    • Days after the crash of Lehman Brothers, the United States Congress approved an emergency bailout package of $700 billion in September 2008.
    • The amount was used to buy off mortgage-backed securities from banks, hedge funds and pension funds to avert further Lehman-type bankruptcies.
    • As a result, fresh money was injected into the banking system for it to resume normal credit operations and clean up balance sheets.
    • Subsequent actions of the US government and Federal Reserve blurred the distinction between fiscal and monetary policy.
    • ‘Quantitative easing’  was a term coined to describe unorthodox measures like a central bank buying off mortgages and loans, and thus taking credit risk onto its balance sheet.
    • So, quantitative easing was pursued by all the major central banks of the developed world.
    • Central banks embarked upon an aggressive money-printing spree. Assets on their books ballooned.

    Monetary response during pandemic subsequent liquidity glut

    • During the pandemic year more than a decade after the 2008 crisis, the West’s monetary spigots have been opened even more.
    • A liquidity glut has ensued.
    • While the rate of monetary expansion over this period has been healthy, neither employment nor economic output grew by even a fraction of that rate.
    • Central bank finds itself in the maze.

    RBI in a similar situation

    • The Reserve Bank of India (RBI) too finds itself in a similar predicament, where the way out of its liquidity glut is hazy.
    • Due to purchases of foreign exchange externally and of government bonds domestically, RBI’s balance sheet has ballooned by more 30% by August last year.
    • RBI has injected liquidity through long-term repo operations, which essentially provide long-term money at low overnight rates.
    • The Indian central bank has also provided implicit liquidity support to mutual funds.
    • However, the RBI has not quite ventured into taking credit risk onto its books, nor has it signalled a readiness to buy toxic assets.

    Liquidity glut and challenges associated with it

    • As a result of India’s liquidity glut, money is flowing in and out of the central bank to the tune of ₹7 trillion on a daily basis.
    • This has resulted in an anomaly: market lending rates have gone below RBI’s reverse repo rate, which is supposed to be the de facto floor.
    • Cheap money encourages to do foolish and risky things, which, if done widely and voluminously enough, can spell disaster for financial stability.
    • But, any hint of reducing the rate of money expansion threatens to cause panic and burst the bubble it blew.
    • So, when RBI tentatively tried to move market rates higher by announcing a reverse repo auction,the market reaction was one of panic all the same, and there was a spike in interest rates.
    • This caused the central bank to rethink its strategy.
    • To calm nervous bond traders, the governor has categorically said that liquidity support will continue as long as necessary.

    Way forward

    •  We need to plan an exit from the current glut.
    • One way out could be loan ₹5 trillion to the central government against shares of public sector undertakings, at a low rate of 3% for a period of five years to fund its huge deficit.
    • That will bypass markets and not cause any disruption to interest rates.

    Consider the question “Why the challenges posed by liquidity glut caused by the unorthodox policies adopted by the central bank in the aftermath of the pandemic? What are the challenges in reducing the liquidity?” 

    Conclusion

    Whatever the way out of this whirlpool of liquidity, it’s not going to be easy.

  • Digital Service Tax could be an interim solution to cyber tax conundrum

    Business models of digital companies challenge the conventional basis of taxation in which the fixed place of business formed the basis. Digital Service Tax could provide a basis to deal with the challenge. The article deals with this issue.

    Equalisation levy and issues with it

    • Equalisation levy seeks to tax payments made for online advertising services to a non-resident business by residents in India.
    • India is amongst the first to have implemented such levy.
    • It is predominantly applicable to US companies since the market for digital services is dominated by US-based firms.
    • Any company that has a permanent residence in India is excluded since it is already subject to tax in India.
    •  In March 2020, India expanded the scope of the existing equalisation levy to a range of digital services that includes e-commerce platforms.
    • Such levy can result in over-taxation since the company will not be able to claim any credit for tax paid on Indian sales.
    • Such an approach is often viewed as contrary to the ethos of international agreements.

    Issue of taxation of digital companies

    • The agenda to reform international tax law so that digital companies are taxed where economic activities are carried out was formally framed within the OECD’s base erosion and profit shifting programme.
    • Worried they might cede their right to tax incomes, many countries have either proposed or implemented a digital services tax (DST).
    • However, the proliferation of digital service taxes (DSTs) is a symptom of the changing international economic order.
    • Countries such as India which provide large markets for digital corporations seek a greater right to tax incomes.
    • The core problem that the international tax reform seeks to address is that digital corporations, unlike their brick-and-mortar counterparts, can operate in a market without a physical presence.
    • The current basis for taxing in a particular jurisdiction is a notion of fixed place of business.

    Way forward

    • To overcome the challenge, countries suggested that a new basis to tax, say, the number of users in a country.
    • The EU and India were among the advocates of this approach.
    • In 2018, India introduced the test for significant economic presence in the Income Tax Act.
    • However, the proposal of a revised nexus was not supported widely.
    • Moreover, to give effect to a new system would require bilateral renegotiation of tax treaties that supersede domestic tax laws.
    • Meanwhile, the OECD continued to work to find commonalities among a range of solutions.
    • In its current form, the solution is too complex to administer and proposes to allocate residual profit — a term that has no economic definition.
    • It would also require political consensus on multiple issues, including sensitive matters such as setting up of an alternative dispute resolution process comparable to arbitration.
    • This can increase the compliance burden.
    • The US has expressed its preference to apply this measure on a safe harbour basis, which can limit the companies to which it may be applicable.

    Consider the question “Digital corporations can operate in a market without a physical presence. The current basis for taxing in a particular jurisdiction is a notion of fixed place of business. In light of this, examine the challenges in taxing the digital companies and how India is dealing with such a challenge?” 

    Conclusion

    As countries calibrate their response to competing demands for sovereignty to tax, DST is an interim alternative outside tax treaties. It possesses the advantage of taxing incomes that currently escape tax and creates space to negotiate a final, overarching solution to this conundrum.

  • What is Section 32A of IBC?

    The Supreme Court has held that the bidders for a corporate debtor under the Insolvency and Bankruptcy Code (IBC) would be immune from any investigations being conducted either by any investigating agencies.

    Q.Examine the impact of various amendments to the Insolvency and Bankruptcy Code (IBC) and suggest further improvements in the IBC.

    Backgrounder: IBC

    • IBC was enacted on May 28, 2016, to effectively deal with insolvency and bankruptcy of corporate persons, partnership firms and individuals, in a time-bound manner.
    • It has brought about a paradigm shift in laws aimed to maximize the value of assets, providing a robust insolvency resolution framework and differentiating between impropriety and business debacle.
    • The predominant object of the Code is the resolution of the Corporate Debtor.
    • It has been amended four times to resolve problems hindering the objectives of the Code.

    What is Section 32A?

    • In cases involving property of a corporate debtor, Section 32A covers any action involving attachment, seizure, retention, or confiscation of the property of the corporate debtor as a result of such Proceedings.
    • It provides immunity to the corporate debtor and its property when there is the approval of the resolution plan resulting in the change of management of control of the corporate debtor.
    • This is subject to the successful resolution applicant being not involved in the commission of the offense.

    What were the challenges?

    • Since the IBC came into being in 2016, the implementation of the resolution plan of several big cases has been delayed because of various challenges mounted by its own agencies and regulators.
    • For example, a debt-laden company, admitted into insolvency in 2017, owes more than Rs 47,000 crore to banks and other financial institutions.
    • After a prolonged bidding battle, another won the rights to take over it with a bid of Rs 19,700 crore.
    • However, before it could move to take over, the ED/SEBI swooped in, and attached assets worth Rs 4,000 crore citing alleged fraud in a bank loan under the Prevention of Money Laundering Act (PMLA).

    Observations made by the SC

    • In its judgment, the apex court upheld the validity of Section 32.
    • It said it was important for the IBC to attract bidders who would offer reasonable and fair value for the corporate debtor to ensure the timely completion of the corporate insolvency resolution process (CIRP).
    • Such bidders, however, must also be granted protection from any misdeeds of the past since they had nothing to do with it.
    • Such protection, the court said, must also extend to the assets of a corporate debtor which will help banks clean up their books of bad loans.
    • The apex court has, however, also said that such immunity would be applicable only if there are an approved resolution plan and a change in the management control of the corporate debtor.

    Significance of SC’s intervention

    • With the Supreme Court upholding the validity of Section 32 A will give confidence to other bidders to proceed with confidence while bidding on such disputed companies and their assets.

    Must read

    [Burning Issue] Insolvency and Bankruptcy Code

  • Secured Overnight Financing Rate (SOFR)

    State Bank of India (SBI) has executed two inter-bank short term money market deals with pricing linked to SOFR (Secured Overnight Financing Rate).

    Try this PYQ:

    Q.The money multiplier in an economy increases with which one of the following?

    (a) Increase in the cash reserve ratio

    (b) Increase in the banking habit of the population

    (c) Increase in the statutory liquidity ratio

    (d) Increase in the population of the country

    What is SOFR?

    • Secured Overnight Financing Rate (SOFR) is a secured interbank overnight interest rate.
    • It is a replacement for USD LIBOR (London Inter-bank Offered Rate) that may be phased out end-2021.
    • The overnight rate is generally the interest rate that large banks use to borrow and lend from one another in the overnight market.

    Why SOFR?

    • Global regulators decided to move away from the Libor, a vital part of the financial system after it was revealed in 2012 that banks around the world manipulated it.
    • It also didn’t help that volume underlying the benchmark dried up.
    • U.K regulators set the deadline at 2021 for financial firms and investors to transition away from the Libor.

  • It’s better to stop the creation of bad debt than set up a bad bank

    The article argues that instead of creating the Bad Bank, several steps taken by the government and the bank regulator could deal with the problem of NPAs and also improve the performance of the banks.

    Challenge of NPA: Is Bad Bank and answer to it?

    • Recently, RBI governor said that the RBI was open to considering setting up of a “bad bank”.
    • India’s economic growth, unless pandemic risks resurface, should be good enough to largely take care of its non-performing assets (NPAs) in the coming years.
    • It was the high economic and credit growth of the 2003-08 period that whittled down the NPA ratio.
    • The provision coverage ratio at banks had gone up from 42% in 2016 to 72.4% in September 2020, and that net NPAs were down to 2.8% in March 2020.
    • The bad loan legacy is almost done with.
    • Consequently, the bad bank is a right idea at the wrong time.

    Steps the government and RBI should take

    1) Resume the operation of IBC

    • The government should reinstate the operation of the Insolvency and Bankruptcy Code (IBC).
    • The code had improved the recovery rate from NPAs in the banking system.
    •  There is a need to create disincentives for deliberate delaying tactics, so that the original timeline of 270 days is honoured more in its observance than in breach.

    2) Recapitalisation of banks

    • The government should provide more than adequate capital to the strong banks it owns, and adequate capital to the not-so-strong ones, with well-defined performance criteria for them to receive more.
    • If they don’t deliver, then the government should consolidate them or begin diluting its stake below 51% in such banks.

    3) Level playing field improvement in compliance culture

    • The government should level the regulatory playing field between private-sector and government-owned banks.
    • The risk management and compliance culture in public-sector banks must improve.
    • However,  public sector banks should not be subject to excessive oversight by government investigative and audit agencies.

    4) Plug the sources of NPAs through policy changes

    • More than these, there are two other important things that constitute the fountainheads of NPAs.
    • The government should evolve a framework for passing on explicit development goals of the state for banks to achieve through the credit mechanism.
    • The government should provide for them in the budget and compensate banks rather than direct credit by diktat.
    • The cost of directed lending is not just the creation of NPAs, but morale and market-value erosion as well.
    • In any case, recapitalization needs mean that the fiscal costs are not avoided. It is self-defeating.
    • Then, governments (Union and states) should plug the other underlying sources of NPAs.
    • Among things, they should ensure economic pricing of utilities, honour power purchase contracts and raw material purchase agreements, pay arrears to private counterparties, and stop being reflexive litigants.

    Consider the question ” What is the Bad Bank? Do you agree with the view that India needs Bad Bank?”

    Conclusion

    The above measures would greatly help the country achieve high growth and sustain it. Setting up a bad bank may be unnecessary.

    Back2Basics: Provisioning Coverage Ratio (PCR)

    • Banks usually set aside a portion of their profits as a provision against bad loans.
    • Provisioning Coverage Ratio (PCR) is essentially the ratio of provisioning to gross non-performing assets (NPA) and indicates the extent of funds a bank has kept aside to cover loan losses.
    • A high PCR ratio (ideally above 70%) means most asset quality issues have been taken care of and the bank is not vulnerable.

  • Balance sheet of a Bad Bank

    The idea of setting up a bad bank to resolve the growing problem of non-performing assets (NPAs), or loans on which borrowers have defaulted, is back on the table.

    Q.What is Bad Bank? Discuss how it is different from an Asset Reconstruction Company (ARC)?

    Why in news?

    • Commercial banks are set to witness a spike in NPAs, or bad loans, in the wake of the contraction in the economy as a result of the pandemic.
    • Hence the RBI recently agreed to look at the proposal for the creation of a bad bank.
    • This is in the response to a six-month moratorium it has announced to tackle the economic slowdown.

    What is a Bad Bank?

    • A bad bank conveys the impression that it will function as a bank but has bad assets to start with.
    • Technically, it is an asset reconstruction company (ARC) or an asset management company that takes over the bad loans of commercial banks, manages them and finally recovers the money over a period of time.
    • Such bank is not involved in lending and taking deposits, but helps commercial banks clean up their balance sheets and resolve bad loans.
    • The takeover of bad loans is normally below the book value of the loan and the bad bank tries to recover as much as possible subsequently.

    Global examples of Bad Bank

    • US-based BNY Mellon Bank created the first bad bank in 1988, after which the concept has been implemented in other countries including Sweden, Finland, France and Germany.
    • However, resolution agencies or ARCs set up as banks, which originate or guarantee to lend, have ended up turning into reckless lenders in some countries.

    Do we need a bad bank?

    • The idea gained currency during Rajan’s tenure as RBI Governor.
    • The RBI had then initiated an asset quality review (AQR) of banks and found that several banks had suppressed or hidden bad loans to show a healthy balance sheet.
    • However, the idea remained on paper amid lack of consensus on the efficacy of such an institution.
    • ARCs have not made any impact in resolving bad loans due to many procedural issues.

    What is the stand of the RBI and government?

    • While the RBI did not show much enthusiasm about a bad bank all these years, there are signs that it can look at the idea now.
    • Experts, however, argue that it would be better to limit the objective of these asset management companies to the orderly resolution of stressed assets, followed by a graceful exit.

    Key suggestions

    Former RBI Dy. Governor Acharya suggested two models to solve the problem of stressed assets.

    1. The first is a private asset management company (PAMC), which is said to be suitable for stressed sectors where the assets are likely to have an economic value in the short run, with moderate levels of debt forgiveness.
    2. The second model is the National Asset Management Company (NAMC), which would be necessary for sectors where the problem is not just one of excess capacity but possibly also of economically unviable assets in the short to medium terms.

    Good about the bad banks

    • The problem of NPAs continues in the banking sector, especially among the weaker banks.
    • The bad bank concept is in some ways similar to an ARC but is funded by the government initially, with banks and other investors co-investing in due course.
    • The presence of the government is seen as a means to speed up the clean-up process.
    • Many other countries had set up institutional mechanisms such as the Troubled Asset Relief Programme (TARP) in the US to deal with a problem of stress in the financial system.

    Pandemic and the NPAs

    • Bad loans in the system are expected to balloon in the wake of contraction in the economy and the problems being faced by many sectors.
    • The RBI noted in its recent Financial Stability Report that the gross NPAs of the banking sector is expected to shoot up to 13.5% of advances by September 2021, from 7.5% in September 2020.
    • The report warned that if the macroeconomic environment worsens into a severe stress scenario, the ratio may escalate to 14.8%.

  • Why Financial boom at a time of economic stagnation?

    Divergence in the financial sector and the overall economy

    • India’s major secondary stock market, the Sensex has been found tracking an upward path, from 40,817 on January 8, 2020, to 48,569 a year later, on January 8, 2021.
    • The trend indicates that GDP in India has been subdued while the financial sector has continued moving up.
    • This paradox has been found to be replicated in other developing as well as advanced economies.
    • These include the major emerging economies such as Brazil and Argentina along with advanced economies such as the United States and the United Kingdom.
    •  It remains an open question whether this paradox can sustain itself.
    • If this cannot sustain, it poses risk for those having large exposures in the financial market and also for the economy as a whole.

    Let’s understand the financial flows beyond the real economy

    • Finance as above, having no counterpart in the productive sector, was identified, first by Karl Marx, as fictitious capital.
    • Earnings from fictitious capital include interests, dividends, and capital gains as well as profits on derivatives.
    • All the above come in the category of unearned or rentier capital.
    • Financial assets, sold with capital gains at higher prices, are met with a rising rather than with the usual declines in demand.
    • Evidently, possibilities of accumulating assets turn even brighter with the high-value assets (used as collaterals), fetching credit for further business.
    • As for the stock prices, which reflect the stream of dividends over time discounted by interest rates, lower rates can help pitch stock prices higher.
    • Cuts in interest rates are often preferred as tools under mainstream prescriptions limiting expansionary policies, which evidently helps stock prices.
    • A journey as above for the financial circuit continues, is subject to market confidence.

    Role of state

    • To look at how finance has attained its present status we need to look at the evolving alliances between finance and the ruling state.
    • The path started with the financial deregulation in the late-1990s when banks were allowed to profit by dealing with securities and with the emergence of hedging devices such as futures and options in the market.
    • It also reflects the rise of non-bank financial institutions as well as shadow banks operating beyond regulations even at cost for the regular banks which had large exposures to the non-banks.
    • The state’s close proximity to big finance is also evident in the revamping of downhill finance, even with bailouts in the name of restoring financial stability.
    • It speaks even more of the pro-finance stance of the government in the neglect of upswings in the financial sector despite the continuing downslides in the real economy.

    Consider the question “What explains the apparent paradox in the India economy with evident divergence in its booming financial sector and subdued economy. What are the risks involved in such situations? Suggest the measures to deal with such situations.

    Conclusion

    Catastrophes, that comes with the sudden collapse of confidence in the financial sector, highlight the need for alternative policies on the part of the state as well as a bit of caution on part of individual investors — in a bid to usher in a sustainable and equitable path of growth for the economy as a whole.

     

  • Bank Investment Company (BIC)

    Banks, especially the Public Sector Banks have to play an important role in the pandemic afflicted economy. With that aim, the government has been envisaging the Bank Investment Company (BIC) for the improvement of PSB governance. The article discusses the issues with the BIC.

    Background of the BIC

    • Recent reports suggest that the upcoming budget may include proposals for a Bank Investment Company (BIC), anchoring the government’s shareholding in its banks.
    • The BIC was proposed by the P J Nayak Committee constituted by the RBI in 2014 to examine governance at public and private sector banks.
    • The committee had offered two options — privatisation or a complete overhaul of bank governance.
    • The overhaul of bank governance is envisaged in the form of a gradual disassociation of the government from the operations, management and governance of PSBs.
    • The BIC is a welcome step in as much as it signals the government’s intent to pursue reforms to improve the governance and performance of PSBs.

    Concerns with the BIC

    • The ownership and governance of the BIC itself will be crucial.
    • BIC will need to be allowed to garner the requisite talent and expertise and operate with freedom.
    • In the absence of this, it would merely add another layer while preserving the status quo.
    • The less than encouraging experience of the Banks Board Bureau (BBB) that was to precede the BIC is instructive.

    Why BBB failed to achieve its objectives

    • The BBB was set up in 2016 to advise on the selection and appointment of senior board members and management.
    • However, in practice, the BBB’s advice has not always been heeded to, and appointments have not always been made on time.
    • The BBB, as originally conceived, was to consist of three senior bankers.
    • However, it was expanded to include representatives from the RBI and the government.
    • The BBB was also originally envisaged by the committee as a temporary arrangement.
    • However, no further steps have been forthcoming after its establishment.

    Way forward for BIC

    • The government would need to ensure the necessary freedom for the BIC to operate while circumscribing its own role.
    • The ultimate success of these reforms will depend on how the government disassociates itself and empowers the BIC.
    • The objectives of the BIC would have to be clearly defined too.
    • If capital raising is one of the goals, the structure of a holding company — with a portfolio of comparatively better performing and non-performing banks — to attract investments must be assessed.
    • In this regard, the RBI has reportedly, in the past, expressed reservations on the BIC structure being a potential challenge for investors to assess the relative risks, returns and performance of the banks.
    • This raises the question of whether privatisation would not be a better alternative, particularly as the transition of the government from an owner to a pure financial investor in its banks is likely to take time.

    Conclusion

    Given these concerns, privatisation may be a better alternative. The budget could signal this intent by announcing the first step — the repeal of the Bank Nationalisation Acts and the State Bank of India Act.