MARKET'S MESSAGE

Indian banks need better governance, not just more money

Quartz india
Quartz india

If there is one thing that the $1.77 billion (over Rs11,000 crore) fraud at Punjab National Bank (PNB) has proved, it is this: Bailing out errant banks with taxpayers’ money can only be first-aid, not a long-term solution.

For those who own shares of India’s state-owned lenders, the scam allegedly perpetrated by jewellers Nirav Modi and Mehul Choksi has eroded the market value of their stocks to where they were four months ago when the government announced a massive Rs2 lakh crore ($32 billion) recapitalisation plan.

On Monday (Feb.19), the sell-off in India’s public sector banks led to a sharp fall in India’s benchmark indices. The Sensex and Nifty closed over a percentage-and-a-half down, the index of state-owned banking stocks fell nearly 5%, and the stocks of 12 public sector banks hit a 52-week low.

The sentiment took a deeper dive after UCO Bank revealed an exposure of Rs2,636 crore to Modi’s firms. A whiff of a similar fraud worth Rs3,700 crore, allegedly by the owner of pen-maker Rotomac, also dented sentiments further.

On Oct. 25 2017, the first trading day after finance minister Arun Jaitley unveiled the government’s massive capital assistance, shares of state-owned banks rallied nearly 1,000 points. PNB alone soared up to 32% that day. Nearly all of that gain has been wiped out—and PNB has lost even more.

To be clear, the government hasn’t announced any change to its recapitalisation plan even after the scam broke out.

The additional money is expected to boost lending and growth in these banks stifled by a surge in bad loans. Besides, India’s state-run banks are also saddled with the government’s political and welfare agenda, a lack of agility in doing business, deficient technology, and other flaws. A fraud is the last thing investors wanted at this juncture.

While they cheered the government support announced in October, the complete reversal in sentiment now goes to show that, in the long run, good governance is valued more.

Both the government and Reserve Bank of India had laid out the ground rules for the recapitalisation plan: the amount infused will take into account the banks’ reform initiatives and not just capital requirements.

“Everything is linked to the reforms which each board will consider within a short time as to what kind of business and how they want to go ahead. It’s not easy money which is going to come, that is the main point,” financial services secretary Rajiv Kumar said in November 2017.

Yet, this thrust on reforms was not visible in the first tranche of fresh capital announced in January 2018. The weakest banks with the most number of bad loans received the biggest chunk of fresh capital. The proposed incentive for prudence and reform was missing.

This slip did not go unnoticed. Less than a month later, the ratio of stock price to book value—an important indicator of valuation—shows India’s private banks as far more treasured than state-run ones.

Private bank stocks are priced at over four times their book value (net worth of a company’s tangible assets), while the State Bank of India, the country’s largest public bank, is trading at about 1.2 times.

In this crisis of confidence, there may lie an opportunity to unleash reforms and improve governance. Throwing money at the lenders alone won’t work.

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