Both Finance Ministry and RBI want banks to shed their non-core business

The Finance Ministry’s eagerness to see banks shed their non-core business is not surprising. With Basel III norms kicking in from January 1, 2013, banks will need to not merely conserve their capital base, but beef it up to meet the additional requirements laid down under Basel III. That’s a tough call even for private sector banks.

But for public sector banks (PSBs) there is an additional challenge. Since the government is unwilling to countenance its stake in these banks falling to less than 51%, the option of tapping the market is virtually ruled out. Unless the government chips in to ensure it remains the majority shareholder, post-issue .

But is that the best use of taxpayer money in a scenario where there are far more pressing claims on the exchequer — roads, primary schools, hospitals, to name just a few — and the fisc is already stretched. As things stand, the government seems unwilling to let economics triumph over politics and give up its fixation about majority ownership in PSBs. That being the case, the next best alternative is to conserve capital by hiving off non-core business.

This fits in with the Reserve Bank of India’s (RBI) own thinking on ring-fencing the banking business. This is to ensure that adverse developments in other businesses do not impact the bank’s balance sheet. Today, many commercial banks, including PSBs have diversified into related areas such as investment banking, mutual funds, insurance, broking, custodial business and primary dealerships.

Such a model is fraught with risks. As the collapse of Lehman Bros, an investment bank has shown, non-bank businesses can also become large enough and inter-connected enough with the banking business as to have adverse systemic consequences in case of failure. This is the reason why the RBI, in its draft guidelines for new bank licences, has urged a different organisational structure for banks. Under the proposed structure, rather than banks spawning subsidiaries for related activities, these activities would be done by subsidiaries of a holding company that would also have a subsidiary banking company. Now for once the finance ministry and the RBI would seem to be on the same page.

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