The Financial Stability Report released by RBI has shown the critical condition of Public Sector Banks. To revive the bank from such calamities high volume of recapitalization is required. There is an expectation that the government will yet again take an easy solution of bailing out weak banks through recapitalization instead of taking up serious reform alternatives.
The government has been constantly supporting sick patients, and neither the banks nor the government has seen any desperation in changing the government structure. There has been a major expansion in the mandate given to the Finance Commissions in their TOR over the years, and these have been issued under Article 280 (3 d), which is “any other matter referred to the Commission in the interest of sound finance”. Recapitalization of public sector banks or the issue of solving their stressed assets is not a part of the TOR. However, the Commission’s interest in this may be to consider the recapitalization requirement as a genuine liability of the Union government while evaluating the central finances.
If recapitalization requirement is taken as a genuine expenditure commitment of the Centre, the resources open for distribution will be severely constrained, and the Commission may have to cut the share of the states in tax devolution from the 41% recommended in the report for the year 2020-21. This will strictly constrain the states’ finances and efforts to revive the economy post-pandemic.
The Nayak Committee has gone a step more and recommended reduction of government ownership to 25%. Privatizing the ownership of the banks will change the structure of incentives and accountability, enabling more effective supervision and guidelines, and subject them to market discipline. Despite these recommendations, the successive governments have continued to de-emphasize the issue.
PSBs, on their part, have been hooked up with battling one crisis after another, be it demonetization or merger. They do not have any interest to take risks and perform better as the government pumps in money from time to time. Reducing the states’ share in the divisible pool of taxes because the Union government requires fiscal space to recapitalize PSBs is as good as penalizing them for the mistakes committed by the Union government.
