The finance ministry has barred government-controlled banks from investing in joint ventures and non-core activities on the ground that capital should only be deployed in 'core' activities.
It has asked banks to take its prior approval before taking such non-core investment decisions and also asked government nominees on bank boards not to pass resolutions to that effect.
In a letter to all the chief executives of public sector banks last month, the department of financial services of the finance ministry said the government had decided to infuse Tier-I capital in the banks on the condition that loans would be extended to the productive sectors of the economy -- the banks' core activity.
Investment in joint ventures, funds and subsidiaries was not core banking activity, it said.
"It will be appreciated that the scarce resource of capital is required to be used strictly for the purpose for which it has been provided.
"Public sector banks are advised not to invest their core capital in non-core banking activities without the approval of the government," the letter said.
Any non-core investment without approval of the government would be viewed adversely, it said.
It further added, "All government nominee directors who are on the boards of public sector banks are requested to ensure that (such) resolutions are not passed."
The ministry diktat comes at a time when public sector banks are looking to enter insurance, mutual funds and private equity.
In recent times, Bank of India has entered into an
agreement to buy Bharti's stake in an asset management company and Punjab National Bank and Syndicate Bank are looking to enter the insurance sector through joint ventures.
Public sector banks look to enter insurance and asset management ventures so that they can offer all financial products to their customers and also earn a fee by distributing those products.
All the large banks such as State Bank of India, ICICI Bank, Bank of Baroda, Union Bank of India and Canara Bank are present in the insurance and mutual fund businesses.
Bankers fear such a directive will jeopardise their decision-making, as they would have to deal with government clearances even for routine investments, like in the public offers of companies.
In the Budget, the government announced it would infuse Rs 15,888 crore (Rs 158.88 billion) in public sector banks for the financial year 2012-13.
Last year, it had infused more than Rs 19,000 crore (Rs 190 billion) in public sector banks, which benefited banks like Punjab National Bank, Bank of Baroda, Allahabad Bank, IDBI Bank and others.
The capital infusion was done by way of preferential allotment of shares to the government and Life Insurance Corporation of India.
State Bank of India, the country's largest lender, received around Rs 8,000 crore (Rs 80 billion) from the government in the last financial year, which boosted its Tier-I capital adequacy.
The government wants all public banks to be well capitalised and maintain Tier-I capital of eight per cent as compared to the regulatory requirement of six per cent within the overall nine per cent capital adequacy ratio.
The finance ministry has barred government-controlled banks from investing in joint ventures and non-core activities on the ground that capital should only be deployed in 'core' activities.