The Indian government has announced a package of comprehensive reforms for their Public Sector Banks (PSU’s). These reforms are part of the Modi Government’s overall reform programme that began last year with their election.
There is a note at the end of our blog is from an Indian broker, for those who want a deeper understanding of the types of reforms. But in summary:
As we say at Morphic: “Change creates Opportunity”. We are optimistic because we believe the groundswell of improvement in the Indian economy which saw the Modi government swept into power suggests now is the time to take on the entrenched vested interests. The Indian government will see many of the existing problems start to dissipate anyway due to macroeconomic tailwinds: bad loans and slow asset growth as well as stubbornly high interest rates caused by the RBI’s determination to end what has been India’s chronically high inflation are now being unwound as the falling oil prices allows rates to be cut which in turn should allow credit expansion to start again.
But to be clear: it isn’t going to be easy. The government banking sector has radical trade unions, some stodgy processes; a history of a some corrupt management who make loans to poor credits for bribes; and a tendency, hopefully in the past of lending to support government initiatives rather than shareholder interests.
If it results in India’spublic sector bank sector banks closing half the valuation gap with private sector banks, a price to book of less than one moves to a price to book of more than two, then the better government banks could go up more than 75% in the next 18 months.
Source: Bloomberg, Team Analysis
We have previously visited almost all the major government controlled banks in India. They vary widely. But what we can say is that they also have some very gifted and dedicated employees who are itching to be liberated from the shackles of the past. We believe the best opportunity is probably in some of the better second ranked (by size) banks like Andhra Bank (based in Hyderabad); Allahabad Bank (based in Calcutta); and Oriental Bank (based in Delhi). These are sound franchises, trading at a big discount to the larger banks that, and this discount always tends to close in an Indian Bank rally anyway.
We have taken initial positions in a selection of these, but are mindful that the timeline of these reforms extends well over one year into two years, so there will probably be other opportunities and points to judge whether the government has been successful in taking on the powerful unions.
From: Hemal Ghia [mailto:Hemal.Ghia@IDFC.COM]
Sent: Tuesday, August 18, 2015 6:49 PM
Subject: Government announces comprehensive reform plan for state owned banks.
Mr Jaitley the Finance Minister, Mr Jayant Sinha, Minister of State for Finance and Mr Hasmukh Adhia, secretary department of financial services unveiled a comprehensive reforms package for state owned banks to the media. The presentation was impressive, but it was not a quantum leap over what is already known. A part of the incentive for doing this press conference was to talk the banks up to enable them to raise money at good valuations from the market (currently they are all trading below book with the exception of SBI which is not a good level to dilute). Even with that we think that the government’s move to lay down a clear vision for banks with specific targets is praiseworthy and will lead to a substantial improvement in the operations of these banks over time. Also, the government formally announced the names of MDs of state owned banks (these names were already out in the press weeks ago). BoB gets the best of the lot – they get a very good private sector MD and a very good non-executive chairman. The reform process is well-intentioned but will take time to show its benefits on profitability and core operations of banks. Short to medium term concerns on asset quality remain and will continue to be the key drivers of stock prices. As such we believe it is still more advisable to stick to the stronger state owned banks that will benefit from these reforms faster than the other PSU banks. We believe BoB is the key beneficiary from the new appointments. Our key picks among state owned banks would be BoB, SBI, Union. Canara Bank is not among the stronger state owned banks. But it does benefit from today’s announcement. Canara too has got a good private sector MD and chairman, so it could do well as a trading bet given its deep discount to other PSBs.
The key takeaways of the reform process are 1) bank boards have been strengthened by splitting the roles of chairman and MD 2) Government has reiterated that they will not interfere in the decision making of banks which is really important given the historical track record of government interference. Each bank will have complete independence to evolve its own strategy. The government will not ask a bank to lend to any corporate house. 3) Private sector participation in bank boards and top management has been initiated with the recent round of appointments 4) Government working on enhancing performance linked bonus for top management of banks, also exploring giving ESOPS to top management. 5) Banking bureau board will be set up by April 2016 with two key responsibilities a) To appoint MDs, chairmen and other top managements of banks. In this it will replace the current appointments committee, which is very positive because the existing process of appointments is non-transparent. B) To help banks evolve their individual strategies . 6) Each bank will be monitored on KPIs which would put more focus on profitability, capital efficiency and asset quality against the earlier focus on balance sheet growth. 7) The government has announced the bankwise capital infusion plan of Rs200bn which will happen by end of this month. An additional Rs50bn will also be likely infused in the better performing, large banks by end of the year. 8)To address stress loans of state owned banks, the finance ministry has set up a separate cell to monitor each of the stressed sectors and within that each stressed project. There is a lot of interaction and deliberation on stress loans between the banks, the Ministry of Finance and the PMO (Prime Minister’s Office).
The following are the key highlights of the comprehensive transformation framework announced by the government today. The government said that the plan comprises 7 elements from A to G as follows:
Appointments: Mr Adhyay reiterated that for the first ever time the government chose to invite private sector to head PSBs. Also for the first ever time the post of the CMD of state banks was split into non-executive chairman and MD. The government formally announced the names of the MDs of five banks where posts were vacant. These names were already out in the press a while ago and are:
In addition non – executive chairmen of key banks have also been announced.
Bank board bureau: The government would set up the Bank Board Bureau by April 2016. The BBB will comprise of a Chairman and six more members of which three will be officials and three experts (of which two would necessarily be from the banking sector). The Search Committee for members of the BBB would comprise of the Governor, RBI and Secretary (FS) and Secretary (DoPT) as members. The BBB would broadly follow the selection methodology as approved in relevant ACC guidelines. The members will be selected in the next six months and the BBB will start functioning from the 01st April, 2016. BBB will replace the existing appointment board. It will have two broad responsibilities: a) To appoint MDs, chairmen and other top managements of banks. In this it will replace the current appointments committee which is very positive because the existing process of appointments is non-transparent. B) To help banks evolve their individual strategies .
Capital infusion in state-owned banks: In line with the earlier announcements, it was reiterated that the government will infuse capital in state-owned banks in three tranches. The first two tranches amount to Rs200bn. The third tranche would be of Rs50bn. The first tranche will go to banks that are low on Tier I in such a manner that all banks have minimum CET 1 of 7.5%. The second tranche will go to the top six big banks viz. SBI, BOB, BOI, PNB, Canara Bank, and IDBI Bank in order to strengthen them to play a vital role in the economy. The third tranche will be allocated to the banks based on their performance during the three quarters in the current year judged on the basis of certain performance. This will incentivize them to improve their performance in the current year. Eight banks which did not get any money in first two tranches will get preference. The government has announced bank wise infusion for the first two tranches totalling to Rs200. This will be infused by August end. The third tranche of Rs50bn will be allocated later.
Timetable for capital infusion: The government has announced a long-term capital infusion plan aligned to the full implementation of BASEL III. The government estimates that Indian banks will need Rs1.8trn of equity capital assuming growth of 12% in FY16 and 12-15% from FY17-FY19. Of this, the government will infuse Rs700bn and banks can raise Rs1.1 trillion from the equity markets. The government is presuming that the emphasis on PSBs financing will reduce over the years by the development of vibrant corporate debt market and by greater participation of Private Sector Banks.
Note: Rs1 crore = Rs10 million
De-stressing and NPL management: To address stress loans of state owned banks, the finance ministry has set up a separate cell to monitor each of the stressed sectors and within that each stressed project. There is a lot of interaction and deliberation on stress loans between the banks, the Ministry of Finance and the PMO (Prime Minister’s Office). The dialogue with states on stressed power distribution companies is also on. The Finance Minister conveyed that the government has told some states that they will have to reform their SEBs otherwise banks cannot go on funding them. Government has decided to establish six new Debt Recovery Tribunals (DRT) (at Chandigarh, Bengaluru, Ernakulum, Dehradun, Siliguri, Hyderabad) to speed up the recovery of bad loans of the banking sector.
Empowerment – No government interference: The Government has issued a circular that there will be no interference from Government and Banks are encouraged to take their decision independently keeping the commercial interest of the organisation in mind. A cleaner distinction between interference and intervention has been made. With autonomy comes accountability, accordingly Banks have been asked to build robust Grievances Redressal Mechanism for customers as well as staff so that concerns of the affected are addressed effectively in time bound manner.
Framework of accountability – Specific, well defined KPIs with focus on profitability and capital efficiency: Each bank will be monitored on KPIs which would put more focus on profitability, capital efficiency and asset quality against the earlier focus on balance sheet growth. The new framework of Key Performance Indicators (KPIs) to be measured for performance of PSBs is divided into four sections totalling up to 100 marks. 25 marks each are allotted to indicators relating to efficiency of capital use and diversification of business/processes and 15 marks each are allotted for specific indicators under the category of NPA management and financial inclusion. The total marks to be allotted for quantifiable, measurable criteria is 80.
Governance Reforms: The process of governance reforms started with “Gyan Sangam” – a conclave of PSBs and FIs organized at the beginning of 2015 in Pune which was attended by all stake-holders including Prime Minister, Finance Minister, MoS (Finance), Governor, RBI and CMDs of all PSBs and FIs. Continuing with this year’s Gyan Sangam, next Gyan Sangam will be held between 14-16.01.2016 to discuss strategy with top level officials.
(ii) The remaining 20 marks are reserved for measurement of qualitative criteria which includes strategic initiatives taken to improve asset quality, efforts made to conserve capital, HR initiatives and improvement in external credit rating. The qualitative performance would be assessed based on a presentation to be made by banks to a committee chaired by Secretary, Department of Financial Services.
Performance linked pays / ESOPs for top management of PSU banks: Operating performance evaluated through the KPI framework will be linked to the performance bonus to be paid to the MD & CEOs of banks by the Government. The quantum of performance bonus is also proposed to be revised to make it more attractive. ESOPs for top management of PSBs will be considered.
Consolidation of PSBs: In response to a question, Mr Jayant Sinha explained that the government will not take the lead in driving M&A among state owned banks. The board of individual banks will have to decide on the business strategy including consolidation.
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