Financials |5Sector Update
January 2015
Sector Update
Financials
Gyan Sangam: not a toothless shark this time!
Suggestions, if implemented, can play a big role in transforming PSU Banks
Please refer to our recent
sector report
dated 26 Dec 2014
Gyan Sangam, a conclave of bankers, industry experts, DFS, RBI, FM and PM, called to
draw a blueprint for banking sector reforms, concluded without any major
announcement related to reforms.
Some of the salient features such as a) PM’s assurance of no political interference on
decision making by respective banks, b) bankers’ suggestions to the governemnt for
creating Bank Boards Bureau (BBB) structure and then move to BIC structure (in line
with Nayak committee recommendation), (c) fully empower banks on HR decisions, (d)
strengthen/improve legal framework for NPA recovery etc, have long term positive
impact on sector and economy if implemented by the government.
The conclave ended without any big bang announcement related to consolidation
(widely rumored by markets) and government left it to the respective bank boards to
take the decision.
One of the commitment by banks to the government is to “Reorient portfolios for
small PSU banks to differentiate, focus on specific niches to build capabilities and to
optimize capital”, which in our view is difficult to implement.
Reforms agenda, although very fluid at this stage, is a vital step to transform PSU
Banks from the social mindset to a more commercially focused institutions.
Move from ‘state-owned’ to ‘state linked’
“Banks would be run
professionally, and there
would be no interference
from the Government”
—
Narendra Modi, PM
For reforming the state-owned banking sector, one of the key suggestion given
by bankers to the government was to set up the Bank Board Bureau (BBB) and
ultimately set up Bank Investment Company (BIC).
As per bankers, creation of BBB and BIC will help in creation of an independent
board and will aid in a) differentiated strategy, b) capital raising, c) M&A and d)
HR policies.
In our view, if BBB/BIC is implemented (in line with the Nayak committee
recommendation) in the right spirit, it would create a more robust state-owned
banking system.
For further details on BBB and BIC as per the Nayak Committee Report, please
refer to page 3
Consolidation – one step closer to reality; differentiated banking in focus
Consolidation of PSU banks has been pending for long and has not made any
headway despite various committees advocating merger of various inefficient
PSU banks.
Focus on reorienting state-owned banks with a differentiated strategic focus
would enable the creation of four to five pan-India banks and a few region
specific nodal banks. However, there was no clarity on when and how the
consolidation process will take place.
We believe the government’s thrust on rebalancing portfolios of small PSU
Banks is essential as it would enable the creation of specific niches among banks
and pertinently aid in optimizing capital.
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Financials | Sector Update
PM promises greater autonomy to state-owned banks
“GoI is open to bold decisions
for professionalization of
management and autonomy in
decision making process”
—
Arun Jaitley, FM
Prime Minister Mr Narendra Modi promised state-owned banks that the
government would not interfere in their functioning, thus setting the stage for
big-ticket reforms in the sector.
Greater autonomy on HR decisions (suggestion if implemented) would enable
banks to hire the best talent, an important step towards market-linked
compensation for PSU bank employees.
Eliminating market distortions like debt waivers and interest caps would
significantly improve the stress asset levels and in turn profitability of the sector.
We believe the reform agenda, although very fluid at this stage, is an important
step in transforming PSU banks from social mindset to a more commercially
focused institutions.
Other highlights
“The government needs to look
at campus recruitment”
—
Raghuram Rajan, RBI Governor
One of the suggestions in PM’s speech on PSU banks is economies of scale (such
as marketing of deposit rates by various PSU banks or technology related cost)
in various cost related items. However, in a commercial business like banking,
where all PSU banks are competing with each other, such kind of pooling of
resources kills the essence of commercial activity and innovation in banking.
Technology will play an important role to increase the market share over the
next decade. The conclave put higher thrust on building infrastructure for digital
banking and deeper mobile banking penetration. Along with technology,
strengthening partnership with business correspondents to meet financial
inclusion objectives remains a key.
Valuation and view
Public sector banks (PSBs) are deep cyclicals, with RoAs of 0.4-0.7% at the
bottom of the cycle and 0.9-1.4% at the peak of cycle. Similarly, P/BV ranges
between 0.4-0.6x and 1.3-2.3x. Valuations are near (for large PSBs) or below the
long period average (20-40% discount for mid-sized PSBs).
Significant steps taken by RBI and government to provide a conducive
environment for recovery cycle will help improve profitability, going forward.
Improvement in operational performance is likely to drive the next leg of re-
rating, with structural reforms taking the re-rating process further.
Our top picks in the PSU banking space are:
SBIN, PNB
and
UNBK.
Exhibit 2: State-owned banks – one-year forward PE
12
9
1.1
1.1
7
4
2
3.9
PSU Banks Sector PE (x)
10.6
7.1
LPA (x)
8.5
Exhibit 1: State-owned banks – one-year forward PBV
2.3
1.8
1.3
0.8
0.3
0.8
PSU Banks Sector PB (x)
1.7
LPA (x)
Source: MOSL, Company
Source: MOSL, Company
5 January 2015
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Financials | Sector Update
Snippets from P. J. Nayak Committee Report
Details on Bank Boards Bureau (BBB) and Bank Investment Company (BIC)
What is BBB as per Nayak Committee?
BBB is an interim arrangement till the transition to BIC structure. BBB will be set
up by the executive order of government.
BBB will comprise of three senior or retired commercial bankers, of whom one
would be the existing Chairman of BBB.
For the process to be credible, board members must be of high standing and
have led banks, and recommended that government should select them in
consultation with RBI.
BBB’s remuneration would also need to be at least that of a serving senior bank
chairman.
As appointments to the top management of banks will continue to require the
concurrence of the appointment committee of cabinet, it is desirable that BBB's
recommendations be generally accepted by the government.
For the accountability of BBB and Appointments Committee of the Cabinet
(ACC) in selection procedure, there should be a public disclosure of all cases of
recommendations made by BBB and which are rejected by the government.
The Nayak committee has proposed that members of BBB be given a tenure of
three years or until powers are passed on to BIC, whichever is shorter.
In phase 1 of transition to BIC, the responsibility of selecting non-official
directors would devolve on BBB. In this phase, BBB will, in consultation with
bank chairmen, strive to bring professionals of good standing on to boards and
de-politicize selections.
Suggestions of Nayak Committee related to Bank Investment Company (BIC)
BIC will be the Core Investment Company under RBI’s registration and
regulations, and character of the same will resemble to that of a sovereign
wealth fund.
CEO (to be selected through the search process) should be a professional banker
or private equity professional with substantial experience in banking.
Non-executive chairman of BIC would be nominated by the government.
All other directors should be independent and bring requisite banking or
investment skills.
BIC employees would be incentivized based on financial returns of the bank.
If required, government’s shareholding in BIC should come below 50%.
All banks’ employees will be obliged to the CEO, CEO to board, board to BIC and
BIC to government (in terms of shareholders agreement).
How the transition to BIC from direct government ownership shall happen?
A) Phase 1: constitution of BIC and assigning responsibility
Important legislative change required: PSU banks’ stake will be transferred to
BIC. Thus, all PSU banks will be required to come under the Companies Act
versus Nationalized Banking Act or SBI Act currently.
Creation of BBB and BIC will
help in the formation of an
independent board and will
aid in a) differentiated
strategy, b) capital raising,
c) M&A and d) HR polices
If required, government’s
shareholding in BIC should
come below 50%
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Financials | Sector Update
Government shall initially hold entire equity of BIC and constitute professional
board for BIC.
All existing ownership function shall be transferred to BIC and non ownership
function such as regulatory and development related shall be transferred to RBI.
Reconstitution of board is
an important step to
improve governance
standards in state owned
banks
B) Phase 2: Actual implementation of reforms start
Reconstitution of board takes place – an important step in our view to improve
governance standards and fixing up of responsibility.
New board members shall be decided by identifying the skill gap, bringing in the
requisite professional with talent and experience in the financial services.
BIC will continue to exercise bank ownership function.
C) Phase 3: Empowering board; BIC function as investor in banks
All the ownership functions will be transferred to respective boards.
Appointment of independent directors, CEOs and other whole time directors
will be banks responsibilities. BIC will have maximum two nominee director on
the board.
As the non-executive Chairman is not an independent director, a lead
independent director would play a helpful role in each bank board, and would
be chosen by the board's independent directors.
In our view, re-orientation
of portfolios of small PSU
Banks would be difficult to
implement
Exhibit 3: Gyan Sangam – Commitment from PSU Banks
Source: MOSL, PIB
5 January 2015
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Financials | Sector Update
Eliminating market
distortions like debt waivers
and interest caps would
significantly improve the
stress asset levels and in
turn, profitability
Exhibit 4: Gyan Sangam - seven point agenda for the government
Source: MOSL, PIB
Move from ‘state owned’ to
‘state linked’ as per Nayak
Committee report should
be one of the first steps in
the reform process
Exhibit 5: Government Banks ownership in large countries
Country
Control
Mechanism
DBS owned through Temasek; DBS Board is fully
Singapore
Govt Investment co.
empowered
Govt Investment co. Fortis and Dexia held through SFPI-FPIM, an investment
Belgium
company
United
Govt Investment co. RBS and Llyods owned through UK Financial
Kingdom
Investments Ltd
Hold majority stake in Banco de Brazil and Caixa; CEO
Brazil
Direct ownership
and most directors appointed by Govt.
Controls 4 largest banks in China; Govt. appoints
China
Govt as sovereign
Chairman and Presidents; Directed lending evident;
Financial stress has necessitated period capital infusions
Source: MOSL, RBI
5 January 2015
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Financials | Sector Update
Exhibit 6: Financials – Valuation Matrix
Source: Company, MOSL
5 January 2015
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Financials | Sector Update
NOTES
5 January 2015
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