The discussion
about State
Bank of India (SBI) has treated one proposition as a given: that
it is the job of the Ministry of Finance to continually inject capital
into SBI so as to enable the growth of the SBI balance sheet; that SBI
has a legitimate claim upon fiscal resources at all times.
I'm not sure this is a good way to think about the business of banking. The first task of a bank should be to produce adequate retained earnings so as to support the desired growth. If a bank cannot produce retained earnings enough to grow, there is reason for thinking that it should not grow.
Let's compare the performance of the best private bank (HDFC Bank) and a good PSU bank (Bank of Baroda) from this perspective.
Let's look at how the two banks have fared, from 1999-2000 onwards, on the core issues of balance sheet growth and leverage:
From 1999-2000 to 2010-11, there has been a sharply superior performance by HDFC Bank. At the start, it was a small bank - with a balance sheet of just Rs.11,731 crore while BOB was roughly 5x bigger. By the end, HDFC Bank was at a balance sheet size of Rs.277,429 crore while BOB was at Rs.358,397 crore.
What is more, HDFC Bank did this while being more prudent: they deleveraged in this period: They went from a leverage ratio of 15.33 to a leverage ratio of 10.93. In contrast, BOB stayed at a much higher leverage (18.12 at the start and 17.07 at the end).
The bottom line: BOB grew net worth by 6.5 times and the balance sheet by 6.11 times. HDFC Bank grew net worth by 33.17 times and the balance sheet by 23.65 times.
In the naive intuition that's being bandied about in the discussion about SBI, there would be an expectation that the expansion of net worth would be obtained by asking shareholders (new or existing) for money. What happened in HDFC Bank and BOB was a bit different.
The hallmark of a healthy bank is the production of retained earnings which can be ploughed back into the business. HDFC Bank did that: over this period, it brought 13.23% of total assets (summing across the 12 years) back into the business, so as to grow net worth. BOB did not do as well: it brought only 7.86% of total assets back into the business.
In addition, HDFC Bank raised 13.66% of total assets by bringing in fresh capital. BOB, in contrast, brought in only 2.11% of total assets into the business. You could criticise the Ministry of Finance for being niggardly in giving BOB equity capital.
A well run bank must put retained earnings back to work. If a bank is unable to fund its own growth by increasing net worth through retained earnings, there is reason to be concerned about the health of the core business.
A steady flow of new capital from shareholders, in order to enable growth, is not that different from recapitalisation in response to bad assets.
Public money is precious. The Ministry of Finance would do well to be very, very stingy in doling out public money to PSUs. Each Rs.5000 crore that goes into a PSU comes at an opportunity cost of 1000 kilometres of NHAI highways which could have been built using that money.
If a PSU cannot grow its balance sheet, odds are the problem lies within: it needs to become a better run business and thus grow the balance sheet using retained earnings. Such PSUs are precisely the ones who are the least deserving to gain fresh capital. If anything, fresh capital should be directed into banks like HDFC Bank (as the private capital markets have), who are doing a great job of producing retained earnings.
I'm not sure this is a good way to think about the business of banking. The first task of a bank should be to produce adequate retained earnings so as to support the desired growth. If a bank cannot produce retained earnings enough to grow, there is reason for thinking that it should not grow.
Let's compare the performance of the best private bank (HDFC Bank) and a good PSU bank (Bank of Baroda) from this perspective.
Growth of the balance sheet and leverage
Let's look at how the two banks have fared, from 1999-2000 onwards, on the core issues of balance sheet growth and leverage:
| 1999-2000 | 2010-11 | |
| Bank of Baroda | ||
| Total assets | 58,623 | 358,397 |
| Leverage | 18.12 | 17.07 |
| HDFC Bank | ||
| Total assets | 11,731 | 277,429 |
| Leverage | 15.33 | 10.93 |
From 1999-2000 to 2010-11, there has been a sharply superior performance by HDFC Bank. At the start, it was a small bank - with a balance sheet of just Rs.11,731 crore while BOB was roughly 5x bigger. By the end, HDFC Bank was at a balance sheet size of Rs.277,429 crore while BOB was at Rs.358,397 crore.
What is more, HDFC Bank did this while being more prudent: they deleveraged in this period: They went from a leverage ratio of 15.33 to a leverage ratio of 10.93. In contrast, BOB stayed at a much higher leverage (18.12 at the start and 17.07 at the end).
The bottom line: BOB grew net worth by 6.5 times and the balance sheet by 6.11 times. HDFC Bank grew net worth by 33.17 times and the balance sheet by 23.65 times.
So how did the net worth grow?
In the naive intuition that's being bandied about in the discussion about SBI, there would be an expectation that the expansion of net worth would be obtained by asking shareholders (new or existing) for money. What happened in HDFC Bank and BOB was a bit different.
The hallmark of a healthy bank is the production of retained earnings which can be ploughed back into the business. HDFC Bank did that: over this period, it brought 13.23% of total assets (summing across the 12 years) back into the business, so as to grow net worth. BOB did not do as well: it brought only 7.86% of total assets back into the business.
In addition, HDFC Bank raised 13.66% of total assets by bringing in fresh capital. BOB, in contrast, brought in only 2.11% of total assets into the business. You could criticise the Ministry of Finance for being niggardly in giving BOB equity capital.
Summary
A well run bank must put retained earnings back to work. If a bank is unable to fund its own growth by increasing net worth through retained earnings, there is reason to be concerned about the health of the core business.
A steady flow of new capital from shareholders, in order to enable growth, is not that different from recapitalisation in response to bad assets.
Public money is precious. The Ministry of Finance would do well to be very, very stingy in doling out public money to PSUs. Each Rs.5000 crore that goes into a PSU comes at an opportunity cost of 1000 kilometres of NHAI highways which could have been built using that money.
If a PSU cannot grow its balance sheet, odds are the problem lies within: it needs to become a better run business and thus grow the balance sheet using retained earnings. Such PSUs are precisely the ones who are the least deserving to gain fresh capital. If anything, fresh capital should be directed into banks like HDFC Bank (as the private capital markets have), who are doing a great job of producing retained earnings.
Ajay,
ReplyDeletePSU banks suffer as they are used as policy vehicles.
- lending targets (agriculture, rural), higher NPA's
- increasing rural branches,
- earnings taken out as dividend by government (compare dividend's of BoB V/s HDFC)
- buying government bonds/securities
Not really a fair comparison with private banks which are run as pure businesses.
It's not like that PSU havent grown there balance sheet or business as whole (by ploughing back earnings)......
ReplyDeletethe inherent weakness of psu lies in the efficiency to deliver...in which they lack...ROA, ROE, Business per employee etc all are not at all impressive enough( ref. to profile of banks 2010-11by RBI.)
But when balance sheet size is five times it is difficult to maintain asset quality and capital adequacy ...(even after manipulation and without accessing capital markets)..which is the cause of downgrade..
Ajay, your comparison is not apple to apple. SBI has a different structure (from BOB) and business objectives (from HDFC). Further, retained earnings are not alone sufficient for future business growth in view of regulatory capital adequacy requirements. capital infusion may be required from time to time. SBI's problem is that GOI does want to dilute its stake further but has no resources to increase the stake. Perhaps, issue of golden share could solve the issue and allow SBI to carry on its business in fulfillmet of its business and national mission.
ReplyDeleteAgree with the above comment, and add that such lending, including those to PSUs, quasi governments (like SEBs), Air India etc. are not only capital destructive, but also extremely low margin even in the best of times! No institution in country generates as much cash single handedly, or can manage the CASA ratios that SBI has, but try and put an equally large burden of financial inclusion and policy implementation on private banks and you will see them unable to finance growth through retained earnings. The Government SHOULD add equity to the bank, or become a minority shareholder.
ReplyDeleteIt is understood the efficiency of PSU vs PSBs in india. HDFC bank refered to here has sharp banking practices which enriches them unfairly.PSUs serve the political whims and hence are constrained in HR practices, adoption of better technologies and poor and or corrupt boardroom practices. There is a long way to go in these matters
ReplyDeleteSBI is the only bank which has given such a good growth to India during liberalisation Despite it's faithful activities ti citizens of India the present UPA and the Sardar at the helm is seeing it's slow down by delaying capitalisation to favour ICIci and HDFC banks
ReplyDeleteYour argument is valid as long as we assume that SBI is a free agent and has real autonomy. If they are doing what the government wants them to - as ONGC and oil companies are forced to - then the government has to provide them the equity.
ReplyDeleteThe government need not rovide equity if SBI is free to seek it elsewhere. If it is not doing so, the government would be acting like a dog in the manger
I guess the obvious question that follows from the comments above, is whether there is a need for PSU banks?
ReplyDeleteWhy should govt be in the business of prescribing lending targets, number of branches, etc? Maybe it is required in the interim as infrastructure gets built up but surely govt should be looking to interfere less and less?
SBI is not the only bank to ask for money through a rights issue to shore up its capital to meet the prescribed norms. At one time ICICI Bank has done it too. That was the most aggressive private sector bank at one time. SBI is not a loss making entity like Air India. So I do not agree with this view at all.
ReplyDeleteThe government wants to retain 51% in SBI and have a right to do so. For that this is required.
Sell Air India. Why argue about SBI's requirements?
Moodys has just decided to snub the Indian government, else the de-rating is very illogical. And in a way it is a wake up call to the government. If you are building up a case for leaving SBI in the lurch it would be a great disservice to India's financial sector as anyway this government knows only to show it is working. This will be one more excuse to do nothing. One Manmohan Singh can't do everything himself, unfortunately.
Sir, this is no offense meant to anyone. It is my personal view as a Finance Professional.
ReplyDeleteThe same logic should have applied to private banks in the west which were bailed out by respective govt.Politicians are least bothered about proper use of public money anywhere in the world.
ReplyDelete"The government wants to retain 51% in SBI and have a right to do so. For that this is required."
ReplyDeleteWhy should the govt have a stake in any bank (not just SBI)?
"If you are building up a case for leaving SBI in the lurch it would be a great disservice to India's financial sector as anyway this government knows only to show it is working."
Please explain what disservice will be caused by this?
Sbi has such a fantastic reach because it opened and ran loss making branches in rural areas for ages, which today are very profitable due to the low cost deposits raised from these same branches. We all know it was for a larger social cause back then.
ReplyDeleteContrast this with the private sector banks worldwide including indian pvt sector icici bank that destroyed money in their over aggression.
I would much rather have sbi and merge more banks in there. A larger social good does tend to make good business sense maybe in the long term. Hdfc,icici bank have chosen to be private sector banks with the sole motive of making profit. Blanket privatisation has not worked in the west either as governments rarely use windfall money efficiently.
So it is food for thought as to whether it would be desirable to let sbi go private.
Anyway the money raised from disinvestment is not used efficiently. That should be set aside for education. Why can sbi not provide concessional student loans? But pursue borrower students vigourously and have them work in the public sector at least for some time.
I am not in favour of blanket privatisation.
If anything is to be abandoned do it to air india. Do it to mtnl, which serves no purpose. Not sbi.
Excesses in the western banking system have also affected PSUs like Fannie Mae. In fact losses in Fannie Mae are arguably the largest. So, I would argue that your assumption that only private banking institutions can cause problems is wrong.
ReplyDeleteThe second assumption you make is that only PSUs can open rural branches. That does not have to be the case as private banks are also regulated by the government and the policies (not just banking but also rural, infrastructure and agricultural policies) would dictate whether banks in general find it useful to expand into rural areas. Its wrong and hypocritical for the govt to dictate opening of banks in areas which are negatively impacted by other poor policies such that banking turns out to be an unprofitable exercise.
Again, I don't understand what social good SBI provides that other private banks don't provide. In fact, they probably provide it much better and much more competitively. Is it not?
Even if the govt infuses capital that is being requested, there will be a further need of capital infusion after 3 years (assuming 15% growth). So, there is no point in leaning to govt every time there is a need for money. The money has to be plough back in to the business and cut on dividend payout. That is the way to grow a business with self-sustaining model.
ReplyDeleteAnother aspect to look at it is the quality of loans. On the asset quality front, the bank's non-performing assets, as of 30 June 2011, reached a three-year high of 3.52 per cent of loans and Rs 27,768 crore on gross basis. The Bank must look at improving the NPA and be selective in doing business.
Fannie Mae is an acquired PSU, and the logic of doing that was more of a necessity from Obama's point of view. The business by itself that was being done by Fannie was inherently faulty, so it had to be acquired and I frankly am foxed with what the U.S. govt. is doing with it. Not being an active analyser of the U.S. economy, I will not go too deep into that. I wonder why the government is not inviting bids for all the companies it has saved from bankruptcy.
ReplyDeletePSUs in India will not be super efficient banks.
Having said that, I do believe that there is a space for them in the Indian context. You yourself say that it is not profitable to open a branch in some areas at the moment. It might be so some time down the line. Today the Niyamgiri Hills in Orissa might not have too many bank branches. Chances are there will be some public sector bank there that is catering to the locals, giving the residents loans at competitive rates, and is not profitable.
No private sector bank will enter there in this scenario. But this same branch could become very profitable down the line. We do not know for sure. It is a possibility.
But my point is banking reaches even where it is not inherently profitable because of the presence of PSU banks, and that is one desirable outcome.
That is why I believe there is a space for BSNL too, as opposed to MTNL.
Your comment that the government should not be in the business of banking is fine if cash is utilised efficiently and the purpose of each entity is clearly defined.
The proceeds of privatisation of family silver is not redirected into capital expenditure but revenue expenditure to reduce fiscal deficits. There cannot be anything more ridiculous than that. That money has to be earmarked for capital expenditure only with a clear statement in the budget as to how it is being used.
Two simple ways for the Government to recapitalize SBI
ReplyDelete1) Don't pay the yearly 2000 crore dividend for this year like last 2 years
2) Don't relax NPA norms and go after defaulters even if they are politically connected i.e airlines, real estate and telecom
3) Let all priority sector funding be put on the back burner and the government be told that once profitability is restored private sector funding can be activated. In this the government can directly put those funds into the hands of poor through cash transfer.
What do you think???
The Government just has to find the funds or fund it through possibly telling LIC to do it or some other PSU with surplus cash and no expansion plans of its own.
ReplyDeleteThat is the bottom line.
All other issues are separate in this case. How the Government has to run will be the subject of a separate article altogether.