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In a move that is likely to attract political controversy, the committee on financial sector assessment has recommended that the banking sector should be gradually opened to foreign players and that the government lower its shareholding in public sector banks below 51 per cent and allow state-owned players to merge if the Centre's stake cannot go below the prescribed lower limit.
The committee, which made its report public on Monday, also reiterated the Reserve Bank of India and government's position that the move towards fuller capital account convertibility should be also be gradual, concomitant with the objective of the achieving a balance in the external and fiscal sectors along with low inflation.
The financial sector assessment programme, which was first undertaken after the Asian economic crisis in 1997, is a comprehensive "health check" to review the strengths, weaknesses and vulnerabilities of the financial system. It also measures compliance with global standards. Unlike last time, the latest exercise was voluntarily undertaken by the government and RBI. Soon, banks may have to undertake periodic stress testing.
The committee, which is headed by RBI Deputy Governor Rakesh Mohan, had members from RBI, finance ministry and other regulatory bodies with four advisory groups with representative from the industry. The reports of the groups were subjected to peer review by international experts.
Overall, the assessment was positive with the committee concluding that the Indian economy would recover from the current slowdown to grow by 8 per cent over the medium-term.
On the flip side, the committee expressed concerns over the government's need to deviate from the fiscal responsibility roadmap and spend more by way of economic stimulus packages and emphasised that it was necessary to return to fiscal prudence at the earliest.
The committee has also called for improvements in the effective enforcement of creditor rights and insolvency systems for quicker resolution of stressed assets of financial intermediaries.
The committee backed the public sector banking system and said that these banks, which accounted for the bulk of the banking system, did not need much recapitalisation. With government assistance these banks would be able to manage up to 25 per cent growth in risk-weighted assets.
Beyond that, the committee said the government would have to consider reducing its stake below 51 per cent, which required legal amendments. In the interim, the committee suggested that the Centre could consider merging banks in which it held close to 51 per cent with those in which its shareholding was higher. At the same time, the committee said synergies in the regional spread of the banks proposed to be merged should be factored in.
In the case of public sector banks, whose capital requirement till 2012-13 was estimated to be between Rs 2,100 crore and Rs 49,500 crore, depending on the pace at which they grow, the committee said that there was a need to lower the floor on government holding below 51 per cent.
The move was pushed by the Atal Behari Vajpayee government, but the proposal was not cleared by Parliament. The UPA government has, however, maintained that the government stake in banks will not fall below 51 per cent but was open to providing additional capital and new instruments to raise capital. A Rs 20,000 crore recapitalisation plan is in the works to ensure that banks have adequate funds to push expansion.
While pointing to the Rs 10,000 crore that was provided to State Bank of India last year to bolster its capital base, the committee pointed out that assistance by way of special bonds might not be most transparent route.
Consolidation in the public sector space has been a bone of contention in the past, with the UPA government unable to push through any merger.
The committee also said off-balance sheet items of banks were rising in recent years and there was a need for a uniform accounts regime across banks and companies. The report said the question of whether banks should enter complex derivatives transactions with only those companies that adopt revised account standards should be considered.
In the case of foreign banks, given the experience in Europe, Latin America and other parts of the world where international entities had a larger presence, the committee was of the opinion that a gradual opening up was best suited for India. The panel suggested that foreign players should be allowed to operate either as a branch or through the subsidiary route, subject to reciprocity and a shareholding cap of 74 per cent. In addition, the committee proposed that the the Indian subsidiary should be listed.
The suggestion is significant given that allowing greater play for foreign banks, including higher voting rights has been a bone of contention, with the RBI keen on permitting foreign players only limited access.
"Stress-testing" the Indian financial sector entities also revealed that despite the current slowdown, the financial sector was safe and met prescribed regulatory norms. Although banks did not face any credit risk, the committee pointed to the adverse impact of some of practices they followed in recent years when credit growth was high. For instance, it said banks should refrain from lending below the benchmark prime lending rate. It also said higher dependence on bulk deposits to fund credit growth could have liquidity and profitability implications.
