Report of The Working Group on Restructuring Weak Public Sector Banks

Summary
Introduction 1. The Reserve Bank of India, in consultation with the Government of India, set up the present Working Group under the chairmanship of Shri M.S. Verma, former Chairman, State Bank of India, and presently Honorary Adviser to the Reserve Bank of India, to suggest measures for revival of weak public sector banks. The terms of reference were (a) criteria for identification of weak public sector banks, (b) to study and examine the problems of weak banks, (c) to undertake a case by case examination of the weak banks and to identify those which are potentially revivable and (d) to suggest a strategic plan of financial, organisational and operational restructuring for weak public sector banks. International experience 2. During the last twenty years, over 130 countries, developed and developing, have experienced banking crises in one form or the other. The Working Group has tried to understand the strategies adopted by some of these countries in the handling of the crises. Restructuring of a banking system needs to address macro systemic issues pertaining to factors responsible for ensuring banking soundness and also the micro level, individual bank problems. While there is no unique solution to banking crises that could be prescribed and applied across the board to all countries, there are some common threads that seem to run through all cases of successful restructuring. Initially, each bank needs to be restored to a minimum level of solvency through financial restructuring. Thereafter, only longer term operational and systemic restructuring can help them maintain their competitiveness and enable them to ensure sustained profitability. Only a comprehensive approach to restructuring can have a lasting effect on the cost, earnings and profits of the banks to be restructured. Public sector banks: an overview 3. Till the adoption of prudential norms relating to income recognition, asset classification, provisioning and capital adequacy, twenty-six out of twenty-seven public sector banks were reporting profits (UCO Bank was incurring losses from 1989-90). In the first post-reform year, i.e., 1992-93, the profitability of the PSBs as a group turned negative with as many as twelve nationalised banks reporting net losses. By March 1996, the outer time limit prescribed for attaining capital adequacy of 8 per cent, eight public sector banks were still short of the prescribed level. 4. The emphasis on maintenance of capital adequacy and compliance with the requirement of asset classification and provisioning norms put severe pressure on the profitability of PSBs. Deregulation of interest rates on deposits and advances has intensified competition and PSBs now have to contend with competition not only from other public sector banks but also from old/new private sector banks, foreign banks and financial institutions. While some public sector

banks have succeeded in adjusting to the changing business environment and managed competition some others have not been able to do so, and have displayed serious weaknesses. 5. The malady has been deep in the case of three banks, viz., Indian Bank, UCO Bank and United Bank of India. Continuous decline in profitability and efficiency of these banks and their dependence on capital support from government are causes for concern. They are trapped in a vicious circle of declining capability to attract good business and increasing need for capital support. 6. It is likely that the seeds of weakness are latent in some other public sector banks as well. The problem of weak banks, which could have spill over effect on the system itself, therefore, assumes serious proportions. 7. The Committee on Banking Sector Reforms (CBSR) had recommended that a weak bank would be one (a) where accumulated losses and net NPAs exceed the net worth of the bank or (b) one whose operating profits less the income on recapitalisation bonds has been negative for three consecutive years. To identify a banks weakness or strength with a fair degree of certainty, the Group has recommended the use of the following seven parameters in conjunction with the two suggested by the CBSR: (i) capital adequacy ratio, (ii) coverage ratio, (iii) return on assets, (iv) net interest margin, (v) ratio of operating profit to average working funds, (vi) ratio of cost to income and (vii) ratio of staff cost to net interest income (NII) + all other income. Identification of weak banks 8. All the public sector banks were evaluated on the above seven parameters keeping the median as the threshold in five of the parameters. For capital adequacy ratio, the threshold was 8 per cent and in respect of the coverage ratio it was kept at 0.50 per cent. 9. Indian Bank did not meet any of the parameters in both the years. UCO Bank and United Bank of India could comply with the capital adequacy prescription but failed in all the other six parameters. These banks, along with Indian Bank, were the only banks to have received capital infusion during the last two years and would not have attained minimum capital adequacy otherwise. 10. The above approach serves the immediate objective of setting the criteria for identifying weakness in banks in general and for locating potentially weak banks. The Working Group, therefore, recommends building a database in respect of banks on an ongoing basis for the purpose of benchmarking and on that basis identifying signals of weakness. Causes of weakness 11. The causes of weakness need to be addressed properly so that the remedial measures adopted prove effective and actually succeed in improving the functioning of the weak banks. The weaknesses relate to three areas: operations, human resources and management. 12. Operational failures mainly relate to high level and fresh generation of NPAs, slow

decision making with regard to fresh sanction of advances and compromise proposals and loss of fund-based advances and fee income. Declining market share in key areas of operations, limited product line and revenue stream, absence of cost control and effective MIS and costing exercise, weak internal control and housekeeping, poor risk management and insufficient customer acquisition due to mediocre service, low level of technology and non-competitive rates are the other causes. 13. The operations of subsidiaries and foreign branches, which are a drain on two of the banks, lead bank and RRB responsibilities and locational disadvantages are also related issues. 14. Overstaffing, low productivity and a high age profile are the main HR related issues. Restrictive practices in deployment of staff have further aggravated the cost of overstaffing. In the three identified banks, staff cost as a proportion of total operating income has been above the industry median. Another area of concern is the level of skill and low levels of motivation. Skills in foreign exchange, treasury management and other specialised areas are not significant enough to generate business in these areas on a sustained basis. 15. Training facilities are not adequate to meet the training requirements of the staff of the banks and motivation and morale of employees at all levels is low. 16. Under management related issues, lack of succession planning, short tenures and frequent changes in top management, inadequate support from the Board of Directors and the lackadaisical implementation of earlier SRPs and MOUs are causes of weakness. Even after infusion of Rs. 6,740 crore in the three banks over the last seven years, their basic weaknesses persist. Unconditional recapitalisation from the Government of India has proved to be a moral hazard as no worthwhile attempt has been made by the banks to gain adequate good business or to reduce costs. Past efforts at restructuring 17. The restructuring efforts initiated so far have not had the desired impact. Hard options have been avoided and the steps taken so far have only had the objective of maintaining the capital adequacy ratio of the banks with the assistance of Government of India. The banks have failed to develop the required resilience or strength to become competitive in the true sense. Present position of the weak banks Indian Bank 18. Indian Bank continued to incur operating losses in 1998-99 also. The capital adequacy which had turned positive and reached 1.41 per cent in March 1998 with capital infusion of Rs. 1,750 crore from the Government of India turned negative again in March 1999. The decline in other income continued during 1998-99 as well. The bank did not make any provision for liabilities arising on account of the proposed wage revision. The deterioration on the NPA front is unabated. Gross NPA went up from Rs. 3,428 crore as on 31 March 1998 to Rs. 3,709 crore as on 31 March 1999, i.e., 37 per cent of gross advances. This was the highest among public sector

banks. UCO Bank 19. UCO Banks operating profit improved marginally in 1998-99. However, if the interest income on recapitalisation bonds is excluded, the bank would have incurred operating loss of Rs. 91 crore in 1997-98 and Rs. 157 crore in 1998-99. Recapitalisation by the government to the tune of Rs. 200 crore helped the bank achieve capital adequacy of 9.63 per cent in 1998-99. The bank has not made provision for liability on account of wage revision. Gross NPAs as on 31 March 1999 aggregated Rs. 1,716 crore (23 per cent). Net NPAs at Rs. 715.63 crore were higher as compared to Rs. 705 crore as on 31 March 1998. The inability of the bank to register any improvement in the net NPA position is a matter for concern. United Bank of India 20. United Bank of Indias operating profit decreased substantially in 1998-99. Operating income increased mainly on account of extraordinary income by way of interest received on income tax refund. Further, if the interest income on recapitalisation bonds is excluded, the bank would have incurred operating loss of Rs. 89 crore in 1997-98 and Rs. 117 crore in 1998-99. Recapitalisation by the Government of India to the tune of Rs. 100 crore helped the bank achieve capital adequacy of 9.60 per cent in 1998-99. The bank has not made provision during 1998-99 for future pension liability and wage revision. The gross NPAs of the bank as on 31 March 1999 increased in absolute terms to Rs. 1,549 crore (32 per cent) from Rs. 1,451 crore as on 31 March 1998 (34 per cent). Net NPAs also went up to Rs. 573 crore (15 per cent) as on 31 March 1999 from Rs. 472 crore (14 per cent) as on 31 March 1998. Assessment of revival plans prepared by the banks 21. The plans prepared by the banks at the Working Groups instance were no better than the earlier ones that had failed in that they continue to be based on ambitious projections of growth in business and income for which the banks are not equipped in terms of skill or technology. The plans do not reflect the growing compulsions of having to achieve steady growth in income and sustained control of expenditure within as short a time as possible. Therefore, the restructuring plans drawn up by the banks do not meet the objectives. It is felt that, as long as government assurance as to continued capital infusion is there, the banks would only look at soft options regardless of the time and cost involved. Future course of action 22. The restructuring exercise has to be comprehensive and must address operational and financial restructuring simultaneously. There is no room for half way measures or gradualism. It is tempting to confine restructuring to financial aspects since solvency is immediately restored and there is a visible impact on the balance sheet. But, if operational aspects are not attended to, long term sustainability cannot be ensured. This will only lead to additional problems necessitating further and costlier restructuring down the road.

23. Future restructuring strategies must incorporate the core principles of manageable cost, least burden on the exchequer, sharing of losses equitably and strong internal governance. There should be an independent agency that will constantly monitor the progress of restructuring. 24. Bank restructuring has been attempted mainly by using one or more of the following modalities: merger or closure, change in ownership, narrow banking and a comprehensive operational and financial restructuring. The Working Group has examined the applicability of each of the above options in the present Indian context. Merger or closure 25. Merger would be advantageous only if it takes into account the synergies and complementing strengths of the merging units. The Working Group does not recommend merger as a possible solution in reviving the weak banks without first preparing them for it. 26. Closure has a number of negative externalities affecting depositors, borrowers, other clients, employees and, in general, the areas served by the banks being closed. This is an extreme option and would need to be exercised after all other options of successful restructuring are ruled out. Change in ownership 27. Privatisation is an acceptable course as this process alone can reduce the governments responsibility of capitalising the three banks further and, in the long run, enable it to recoup, fully or partially, the investment made in their capital. This will remove the moral hazard implicit in the present situation that government support will always be available and make the three banks responsive to the rules of market economy. The three banks will then also have a sense of accountability to all the stakeholders and appreciate the need for good performance. 28. However, in their present state, it is just not possible to consider their privatisation because the cost of restructuring is prohibitively high and no private group can normally be expected to bring in the kind of resources that the three banks require at present. These banks are also not likely to succeed in accessing the capital market given their present position. Their present staffing pattern and level of skills and technology will be deterrents to any investor. Narrow banking 29. All the three weak banks have pursued some form of narrow banking, without success, for reasons such as inability to lend to quality customers, as a matter of deliberate policy, high levels of NPAs and fear psychosis. Preferring government securities to fresh lending creates dissatisfied borrowers who tend to change their bank. Banks ability to generate non-interest income is linked to the size and quality of their advances portfolio. A restriction on this results in a fall in fee income. Such a two-pronged loss in income adds to the weakness of the bank making its recovery even more difficult. Further, resorting to narrow banking does not protect a bank against all risks as even investments in gilts are open to market risks. In any case, narrow banking can at best be only a temporary phase and cannot by itself be adopted as a restructuring

strategy. Comprehensive operational and financial restructuring 30. With the three other options not being found suitable to the present environment, the only other option left for consideration is that of a comprehensive operational and financial restructuring. The Group has tried to answer the question whether this option of restructuring is available in the case of the three identified weak banks. 31. The three banks are obviously beset with serious weaknesses and have not been able to turn around despite repeated recapitalisations almost all through the 1990s adding up to a massive sum of Rs. 6,740 crore. They continue to depend upon the government for further recapitalisation and Indian Bank alone will need another Rs. 1,000 crore urgently to gain the prescribed minimum capital adequacy of 9 per cent with no guarantee that at the end of the current year, they will once again not need further infusion of capital to maintain this ratio. The position of the other two banks is only marginally better as they do not need capital infusion immediately. However, their future operations too are unlikely to continue without further infusion of capital. It does not, therefore, make economic sense to let them continue in the present manner for, after all, the government cannot undertake to capitalise them endlessly. 32. It is, therefore, time to take a long term view and ensure that the present state of affairs does not get prolonged. The choice is, therefore, limited to either closing them or subjecting them to such extensive operational, organisational and financial restructuring as can effectively restore their competitive efficiencies. 33. In view of the very extensive network and large client base of each of these banks, as also the other attendant negative externalities, closure is to be considered only as the last option. The choice of comprehensive restructuring, therefore, requires careful consideration. Any such restructuring, however, will mean exercising hard options and involve firm, decisive and timely actions. There must be a firm political will backed by firm commitments from the bank management and the employee unions that the restructuring exercise will be completed without any let up or hindrance. The management and employee unions of the banks will have to come to an agreement before the restructuring exercise begins as regards every important ingredient of the proposed exercise. The crux of the issue is that it is going to be an expensive one-time exercise and, unless its success is reasonably assured, it will not be worth undertaking. 34. Subject to what has been stated above, the Group has developed a four-dimensional comprehensive restructuring programme covering operational, organisational, financial and systemic restructuring. These are as under: 1. Operational restructuring involving i. basic changes in the mode of operations,

ii. iii. iv.

induction of modern technology, resolution of the problem of high non-performing assets and drastic reduction in cost of operations.

2. Organisational restructuring aimed at improved governance of the banks and enhancement in management involvement and efficiency. 3. Financial restructuring with conditional recapitalisation.

4. Systemic restructuring providing for, inter alia, legal changes and institution building for supporting the restructuring process. Operational Restructuring 35. In a well-researched document published by the IMF in 1997, one of its contributors, Gillian Garcia, has identified the following as key elements of operational restructuring: a. Formulating a business plan that focuses on core products and competencies. b. Reducing operating costs by cutting staff and eliminating branches where appropriate, ceasing unprofitable activities, and disposing of unproductive assets. c. Implementing new technology and improving systems of accounting, asset valuation, and internal controls and audit. d. Establishing and enforcing internal procedures for risk pricing, credit assessment and approval, monitoring the condition of borrowers, ensuring payment of interest and principal, and active loan recovery. e. Creating internal incentive structures to align the interests of directors, managers, and staff with those of the owners. The Working Group considers the above to be a very good and concise statement of operational restructuring requirements. The plan evolved by the Working Group for restructuring of the three banks is also on similar lines. 36. Operational restructuring for the weak banks is two pronged: one of increasing income and the other of reducing costs. Income has to be increased by revamping the banks mode of doing business and by reducing the effect of current and future NPAs on their earnings. Cost reduction will have to be achieved by dropping the lines of business and products that are proving to be a drag on their profitability and effecting reduction in staff costs which account for most of the operating costs incurred by the weak banks. Change in mode of operations

37. None of the weak banks is identified with any special business or customer niche. Each of them, therefore, needs to develop strengths in chosen areas and build its skills and business strategy around those strengths. By trying 12 to be all-India banks, they are neither any more dominant in the area of their concentration nor are they able to make a mark countrywide. 38. The growth of these banks credit portfolios has been extremely limited and their feebased earnings minimal. They need to take urgent steps to reintroduce credit culture and ensure a rapid growth in non-fund based earnings by laying stress on a few selected services, particularly, movement and management of funds. 39. These banks had left the traditional areas of business in which they had experience and moved into areas for which they neither had skills nor the experience and this has been their undoing. They need to go into areas in which they have the experience and can develop expertise in a short time. The appropriate markets for them will be the middle and lower segments of the credit market. 40. Unions have pleaded for allocation of a share of the PSU and other government departments related business. Such an approach is not practical nor is it desirable especially in the present deregulated environment where the banks need to stand on their own and where these bodies themselves are autonomous in their functioning. Foreign branches and subsidiaries 41. Both UCO Bank and Indian Bank would find it extremely difficult to run their foreign branches in the short and medium term. The position even now is tenuous and would get exacerbated if any of these operations runs into the slightest of difficulty or if the local regulators stipulate conditions regarding capital adequacy which the banks may not be able to meet. This could pose a problem for not only the three banks but also for the Indian banking system. These branches need to be taken off their hands by selling them to 13 prospective buyers including other Indian public sector banks. The resources raised could fund some of the various demands of the restructuring operations. 42. The subsidiaries of Indian Bank are likely to be a continued drag on its viability and would add to the cost of restructuring. A decision to close them needs to be taken at the earliest. An effort could also be made to find buyers for the banks holdings in the subsidiaries. Adoption of modern technology 43. Public sector banks, particularly the weaker ones, are losing ground and share of business to the technologically well-equipped new private sector as well as foreign banks. The weak banks do not have either the skills or the resources to implement and maintain complex IT solutions of the kind that are required to meet the challenges. A desirable solution would be to

have common networking and processing facilities. Such common facilities may be outsourced from an existing reputed company. The service provider could also be invited to follow a Build Own Operate Transfer model for this purpose. 44. Implementation of an IT solution in the above manner will, among other things, enable introduction of extended working hours and shifts and improve overall customer service. In the first stage itself, which may be spread over twelve to eighteen months, the IT solutions should target coverage of over 70 per cent of the participating banks present business. This would require that around 250 to 300 of the largest branches from each of the three banks be linked to the proposed outsourcing. The Working Group has estimated the total cost for this at Rs. 300 crore which may come by way of assistance from the government or from multilateral lending institutions. NPA management 45. NPAs have been the most vexing problem faced by the weak banks with additions to NPAs often outstripping recoveries. A significant portion of the NPAs are chronic and/or tied up in BIFR cases. There are also loans given to state and central public sector units which have failed to repay. The operations of Debt Recovery Tribunals are such that they have not so far made a dent in the NPA position of banks. The route of compromises has also not been very successful despite setting up of Settlement Advisory Committees. It is necessary that measures are found to ensure an early resolution of chronic NPAs. Where guarantees have been given by the central or state governments and where these have been invoked by the banks, these demands need to be met. 46. Separate institutional arrangements for taking over problem loans have played a key part in bank restructuring in different countries with varying degrees of success. The Committee on Financial System (1991) and the CBSR (1998) had made similar recommendations. Such separation of NPAs is an important element in a comprehensive bank restructuring strategy. 47. It would be desirable to develop a structure which will combine the advantages of government ownership and private enterprise. The broad structure would be that of a government-owned Asset Reconstruction Fund (ARF) managed by an independent private sector Asset Management Company (AMC). Assets belonging to public sector banks can be transferred to the ARF. The ARF will be constituted with the objective of buying impaired loans from the weak banks and to recover or sell them after some reconstruction or in an as is where is condition. The ARF may be set up by the proposed Financial Restructuring Authority under a special Act of the Parliament which while protecting it against obstructive litigation from the borrowers could also provide for quick and effective enforcement of its rights. The ARF may be required to acquire assets of the face value of about Rs. 3,000 crore. The capital needed by the ARF would be in the region of Rs. 1,000 crore. 48. The payment in respect of the assets purchased from the weak banks may be made by the ARF by issuing special bonds for the purpose bearing a suitable rate of interest. It may also be guaranteed by the government in order to improve its liquidity. The bonds may, however, be issued to the weak bank with an initial lock-in period of at least two years. These bonds as also

those which will be issued for raising funds against the security of assets purchased by the ARF may have a maturity of five years. 49. The ARF should purchase from the banks loans, which are NPAs as on a certain date, say, 31 March 2000. The responsibility of recovering loans, which become NPAs after that date should remain totally with the banks concerned. It will, therefore, be adequate for the ARF to have a life of not more than seven years. The ARF may buy NPAs only from the banks which have been identified as weak, though the option of buying loans from other banks should not be closed. It should be possible to set up more such funds later if the need arises. 50. The transfer price has to be fair to both the buyer and the seller. It would be difficult to prescribe rigid arrangements or a floor price for the transfer of NPAs and each case may have to be decided on merits. So long as pricing is arrived at by mutual agreement and in a transparent manner, the Group does not consider it necessary either to prescribe a floor price or a formula therefor. 51. The management of the ARF would be entrusted to an independent Asset Management Company, a private sector entity, which will employ and avail of the services of top class professionals. The AMC can be compensated for the services it provides in the form of service commission on the value of assets managed coupled with incentives for recoveries if these are higher than an agreed benchmark. 52. In the ownership of the AMC, while the government would have a fair, may be even dominant, share of up to 49 per cent, majority shareholding will be non-government. The other shareholders could be institutions like SBI, LIC, GIC, UTI and IFCI whose participation does not add to government shareholding and also parties from the private sector. The initial capital requirement of the AMC is not likely to be more than Rs. 15 crore and it would, therefore, not be difficult to attract non-government participants therein. It would also be possible to attract participation of multilateral agencies like IFC or ADB. The possibility of an existing Fund Manager, in public or private sector, offering to manage the ARF may also be explored. 53. To the extent that NPAs are taken off the books of the three banks and are moved on to the Asset Reconstruction Fund, the Fund would be paying them for the assets taken over by way of bonds bearing interest. This interest earning will add to the concerned banks income which to a considerable extent will help the bank in meeting their staff expenses. Assuming that NPAs will be transferred at a rate so as to bring them down to the average level of NPAs in PSBs which is around 15 per cent, the annual income for Indian Bank, UCO Bank and United Bank of India can be expected to be augmented by around Rs. 91 crore, Rs. 44 crore and Rs. 24 crore respectively. Reduction in cost of operations 54. Cost income ratio of the Indian Bank, UCO Bank and the United Bank of India for the year 1998-99 worked out to 141.22, 93.94 and 89.90 per cent respectively showing clearly that the cost of their operations has reached unsustainable levels and that, unless the situation is corrected immediately, survival of these banks could be in jeopardy.

55. The cost of operations of the three banks is clearly unsustainable and is threatening long term viability and survival of these banks. When it comes to cost management and reduction, non-staff expenses are far less critical than staff expenses. These comprise of expenses incurred on items governed by market conditions over which banks have little or no control. 56. Management of costs necessarily boils down to management of staff expenses which in the year 1998-99 accounted for 76.37 per cent and 80.60 per cent of the total operating income (NII + all other income) in UCO Bank and United Bank of India respectively. In the case of Indian Bank, the position was much worse at 107.79 per cent. Other similarly placed public sector banks have this ratio generally below 45 per cent. Banks which have to allocate a comparatively lower portion of their overall income towards their staff costs obviously have a tremendous competitive advantage over the others. 57. Since chances of increasing income in the short term are remote, the weak banks have little choice but to take all possible measures to reduce their staff costs and bring it in line with at least the average performing public sector banks in terms of its percentage to total operating income (net interest income + non-interest income). 58. The three banks have not factored in the wage revision that is to become effective from November 1997. No provision in respect of the increase (12.25 per cent) has been made and should it become applicable to them not only will the yearly wage bill for the future years go up but substantial amounts will also go towards arrears for the period beginning from the date from which the revision becomes effective. 59. With the added income from transfer of NPAs in the form of interest on the relative bonds, the requirement of staff reduction would get suitably modified and has been estimated to be of the order of 30 to 35 per cent in the three banks. Considering all factors involved, the Group is of the view that initially a reduction in the staff strength of the order of 25 per cent may serve the purpose and should, therefore, be aimed at. This reduction in staff strength would help the banks reduce staff costs correspondingly which going by the expenses incurred in the year 1998-99, would work out approximately to Rs. 107 crore, Rs. 121 crore and Rs. 85 crore in the case of Indian Bank, UCO Bank and United Bank of India respectively. 60. This step is unavoidable since continuing with the present strength could jeopardise the survival of the three banks. In order to control their staff costs, the three banks will have to resort to a voluntary retirement scheme (VRS) covering at least 25 per cent of the staff strength. It is estimated that a reasonable VRS for the three banks aimed at 25 per cent reduction would cost between Rs. 1,100 and Rs. 1,200 crore. 61. The rightsizing of staff will have to be achieved by the individual banks structuring their schemes in such a way that they are able to maintain the required balance between the different categories of staff and do not lose the desirable experience and skills they possess. The scheme will have to be voluntary but the right to accept or reject individual applications should rest with the management. The scheme should aim at separation of employees in the age group of 45 and above especially those in the 50-55 age group. The scheme should be in operation for a period

not exceeding six months. The banks will need to undertake considerable retraining and relocation of the post-VRS staff strength. Such reskilling and relocation should be made a precondition for future recapitalisation. 62. In order that the VRS and the needed reduction in staff costs have a real impact on the operating results of the banks concerned, it would also be necessary to place a cap on the staff expenses of the three banks. Towards this, the Working Group recommends that a freeze on all future wage increase including the one presently under contemplation, i.e., with effect from November 1997, be put in place. This may continue for a period of five years. 63. If VRS does not lead to the needed reduction in the banks operating costs, there will be no alternative left but to resort to an across-the-board wage cut of an order which will result in a similar reduction in costs. It is with this urgency in mind that the Working Group has suggested keeping the VRS open for a limited period of six months. 64. The only other source of sustenance in these cases is recapitalisation support from the government but this too is not readily available because of the increasing pressures and other compelling demands on the governments resources. If, therefore, the banks are to survive, most efforts and sacrifices will have to be their own. Outside support can only be limited and short term and will be predicated upon what the banks can do themselves. Organisational Restructuring 65. The complex administrative structure of the weak banks is a serious limitation impairing their decision making process. Each of these layers is delay laden and without any clarity of policies and purpose. Even though some delayering has been attempted in some banks, especially, UCO Bank, the administrative structure continues to be diffused. Delayering alone would not speed up decision making unless accompanied by clearly laid out policies and procedures, skills and adequate discretionary powers at the different levels of decision making. 66. The three banks have a larger network of branches than what their levels of business call for. There is also the question of concentration of branches in specific areas with which United Bank of India and UCO Bank are faced. There is an urgent need to consider rationalisation of branches in all the three weak banks. 67. The weak banks must take a hard and careful look at the branches the levels of business of which are below 50 per cent of the level of nationalised banks in similar area and after convincing themselves about their unviability decide to discontinue their operations By continuing such operations, hoping that these will improve in future or by showing them artificially as profitable using a transfer pricing mechanism which favours them unduly, the problem will be compounded and elude solution even in future. It, therefore, stands to reason that the banks merge two or more unviable operations into one viable operation. 68. Absence of dynamic leadership for long periods has been a major contributor to the consistent deterioration in the functioning of the three banks. There is a need for appointing CMDs who are especially suited to their jobs and are more in the nature of wartime generals

possessing special skills and attitude required for restructuring. They should have a sufficiently long tenure of, say, four to five years and should be in the age group of 50-52 years. In order to ensure uninterrupted progress of the restructuring plan and to commit the top management thereto fully, this tenure may not be ordinarily curtailed. The right persons for these jobs should be provided with incentives, both monetary and non-monetary, for achieving the restructuring mission successfully even if giving such incentives means making a departure from existing norms. If in the four or five year career of a person as CMD of a weak bank the bank shows a definite improvement, he could be considered for heading one of the prime banks/financial institutions in the country. 69. A line of succession should be developed well in time and a system put in place whereby, save exceptions, an ED would succeed the outgoing CMD. Excepting in very small banks, there should be two EDs. One of the two EDs could be responsible for driving the restructuring process leaving the CMD free to pursue other strategic growth issues. 70. The boards need to be reconstituted to include eminent professionals, industrialists and financial experts with the necessary training, experience and background. There should be a clear distinction between the roles of ownership, which the government has, and that of management, which it does not. The government may, therefore, consider withdrawing from the banks boards its own serving officers and replace them with independent nominees having relevant knowledge and experience. 71. Leadership is lacking in the middle levels of these banks because of inadequacies in skills both in the traditional areas of bank operations as well as in new and specialised areas such as credit, treasury operations, foreign exchange and IT. While a longer term training and reskilling programme will have to be undertaken, the banks would also need to resort to some recruitment in the senior and middle levels of management from the market. 72. The training facilities are inadequate to meet the needs that would arise following the restructuring efforts. These will have to be considerably strengthened. Training facilities created by more than one bank could be pooled for optimum utilisation of the limited training skills available. A sub-allocation out of the capital support earmarked for VRS may be made for reskilling and training. Financial restructuring 73. Financial restructuring has to be undertaken to ensure solvency. Capital infusion in the three identified weak banks has so far aggregated Rs. 6,740 crore. Further capital infusion in the case of Indian Bank is imperative to ensure its continued operations. Financial restructuring should aim at raising CAR to at least one per cent above the minimum required so that the banks can continue with their normal credit business. 74. To the extent immediate cash funds are not being made available, the present mode of recapitalisation by way of recapitalisation bonds may be continued. A portion of the additional capital requirement would need to be provided in cash in the form of either preference capital or long term subordinated debt. On this, the banks should have an obligation of giving a return.

Without this, they will fail once again to appreciate the necessity of developing minimum competitive efficiency and their obligation to service capital. Recapitalisation must be accompanied by strict conditions relating to operating as well as managerial aspects of the recipient banks working. Conditions should also apply to the manner in which these funds can be deployed. 75. Additional capital is required to meet the cost of (a) moving some portion of the NPAs out of the books, (b) cost of modernisation of technology, (c) HRD related costs including that of VRS, relocation and training and (d) capital adequacy. Funds required under (b) and (c) will have to come by way of cash. Requirements for items under (a) and (d), however, can be met through recapitalisation bonds as hitherto. Funds should become available only when the banks undertake the specific activities for which these have been earmarked. 76. Recapitalisation should be under an agreement, between the government on the one side and the banks Board of Directors, its management and staff and employee unions on the other, laying out the restructuring goals. The agreement, while stating clearly the extent of governments involvement and the responsibilities of the bank, should also contain details of the banks obligations to perform and report, precise milestones for performance and measures that will follow non-performance, treatment of NPAs and near term improvements in operating results. It would also be desirable to assign selected financial indices for the bank to follow within a timeframe. The performance under this agreement will have to be monitored closely. 77. The overall cost of restructuring the three banks over the next three years is estimated by the Working Group to be of the order of Rs. 5,500 crore. A purpose-wise break-up of the required amount is given below. a. b. c. d. Technology upgradation VRS NPA buyout For capital adequacy Rs. 300-400 crore Rs. 1,100-1,200 crore Rs. 1,000 crore Rs. 3,000 crore

The estimate could turn out to be inadequate if some hidden surprises surface or some delays or other roadblocks are encountered in the course of implementing the programme. Systemic Restructuring 78. In order to ensure success in restructuring of weak banks, Government of India should also consider setting up of an independent agency, say, Financial Restructuring Authority (FRA), to co-ordinate and monitor the progress of the programme. It will represent the owner, in this case the Government of India and, vested with due authority from the government, be able to give the banks undergoing restructuring, guidance and instructions for proper implementation of the programme including course corrections wherever necessary. It will approve bank specific restructuring programmes, enter into agreements with individual banks covering the terms and conditions of the programmes and follow up its progress with the bank and other concerned agencies. Among other things, it will also act as an owner of the Asset Reconstruction Fund on behalf of the government and ensure its proper governance. It would be desirable to set up such

an authority under an Act of the Parliament so that with the force of law behind it the FRA enjoys a distinct individuality. The FRA is not being conceived as a permanent body as it is expected that, with the completion of the restructuring process of the weak banks, it would have outlived the utility of its existence and would be wound up with the winding up of the ARF it will own. 79. It will facilitate the process substantially and help effective implementation of the restructuring programme if within the Reserve Bank of India, a special wing is formed for regulating and supervising weak banks. On a number of issues like deposit insurance, regulation of subsidiaries, risk management, disclosures and regulatory compliance, the treatment of weak banks would need to be different from those of much stronger normal banks. This arrangement would also help early detection of and attention towards weaknesses emerging in other banks pre-empting a systemwide spread of their problems. 80. Prolonged litigation prompted by legal lacunae in different commercial enactments is one of the main reasons for the increase in the size of the banks NPAs. Some of these enactments are several decades old and, in quite a few cases, out of line with the present day realities. These provisions need to be amended urgently and some new enactments are called for in order to cater to the requirements of the changed and far more complex current economic and business environment. 81. Countries like Thailand and Malaysia which have undertaken extensive bank restructuring recently have within a short period enacted amendments to their bankruptcy laws and improved provisions for foreclosures and court procedures to ensure speedier enforcement of lenders claims. Malaysia is also setting up specialised bankruptcy courts and steps have been taken there to plug loopholes that previously allowed borrowers to contract additional debts or dispose of their assets while restructuring was being worked out. Our problems are similar and it would be of great help to banks efforts in managing their NPAs if comparable laws are suitably enacted/amended urgently. 82. DRTs have helped the recovery process of the banks only in a limited manner. Their functioning is under review. Till necessary amendments to the Recovery of Debts Due to Banks and Financial Institutions Act, 1993, are made, steps should be taken to remove the administrative and infrastructural problems relating to the DRTs to improve and facilitate their effective functioning. Insofar as the recovery process of weak banks and the ARF is concerned, an arrangement may be worked out for the DRTs to attend to their cases on a priority basis. 83. The investigations into accountability both at the bank and at the level of non-bank agencies if completed in a time bound manner would go a long way in ending uncertainties and help in the overall improvement of morale of the staff. A time bound approach is absolutely necessary for creating appropriate conditions in banks in general and in weak banks in particular. Concluding remarks 84. The restructuring programme will have to encompass operational, organisational, financial and systemic restructuring and must be implemented in a time bound manner. Any

delay will add to the cost of the restructuring. The different measures suggested by the Group for financial, operational and systemic restructuring are a unified package and for results to be really achieved have to be implemented as such. A stage has reached when gradualism will not succeed and if resorted to may cause more harm than good. By adopting a pick and choose approach, not only a total effect expected from the package will be lost, but even the individual measures picked up for implementation would lose much of their efficacy.

Report of the Working Group on Restructuring Weak Public Sector Banks

Summary
Introduction 1. The Reserve Bank of India, in consultation with the Government of India, set up the present Working Group under the chairmanship of Shri M.S. Verma, former Chairman, State Bank of India, and presently Honorary Adviser to the Reserve Bank of India, to suggest measures for revival of weak public sector banks. The terms of reference were (a) criteria for identification of weak public sector banks, (b) to study and examine the problems of weak banks, (c) to undertake a case by case examination of the weak banks and to identify those which are potentially revivable and (d) to suggest a strategic plan of financial, organisational and operational restructuring for weak public sector banks. International experience 2. During the last twenty years, over 130 countries, developed and developing, have experienced banking crises in one form or the other. The Working Group has tried to understand the strategies adopted by some of these countries in the handling of the crises. Restructuring of a banking system needs to address macro systemic issues pertaining to factors responsible for ensuring banking soundness and also the micro level, individual bank problems. While there is no unique solution to banking crises that could be prescribed and applied across the board to all countries, there are some common threads that seem to run through all cases of successful restructuring. Initially, each bank needs to be restored to a minimum level of solvency through financial restructuring. Thereafter, only longer term operational and systemic restructuring can help them maintain their competitiveness and enable them to ensure sustained profitability. Only a comprehensive approach to restructuring can have a lasting effect on the cost, earnings and profits of the banks to be restructured. Public sector banks: an overview 3. Till the adoption of prudential norms relating to income recognition, asset classification, provisioning and capital adequacy, twenty-six out of twenty-seven public sector banks were reporting profits (UCO Bank was incurring losses from 1989-90). In the first post-reform year, i.e., 1992-93, the profitability of the PSBs as a group turned negative with as many as twelve nationalised banks reporting net losses. By March 1996, the outer time limit prescribed for attaining capital adequacy of 8 per cent, eight public sector banks were still short of the prescribed level. 4. The emphasis on maintenance of capital adequacy and compliance with the requirement of asset classification and provisioning norms put severe pressure on the profitability of PSBs. Deregulation of interest rates on deposits and advances has intensified competition and PSBs now have to contend with competition not only from other public sector banks but also from old/new private sector banks, foreign banks and financial institutions. While some public sector

banks have succeeded in adjusting to the changing business environment and managed competition some others have not been able to do so, and have displayed serious weaknesses. 5. The malady has been deep in the case of three banks, viz., Indian Bank, UCO Bank and United Bank of India. Continuous decline in profitability and efficiency of these banks and their dependence on capital support from government are causes for concern. They are trapped in a vicious circle of declining capability to attract good business and increasing need for capital support. 6. It is likely that the seeds of weakness are latent in some other public sector banks as well. The problem of weak banks, which could have spill over effect on the system itself, therefore, assumes serious proportions. 7. The Committee on Banking Sector Reforms (CBSR) had recommended that a weak bank would be one (a) where accumulated losses and net NPAs exceed the net worth of the bank or (b) one whose operating profits less the income on recapitalisation bonds has been negative for three consecutive years. To identify a banks weakness or strength with a fair degree of certainty, the Group has recommended the use of the following seven parameters in conjunction with the two suggested by the CBSR: (i) capital adequacy ratio, (ii) coverage ratio, (iii) return on assets, (iv) net interest margin, (v) ratio of operating profit to average working funds, (vi) ratio of cost to income and (vii) ratio of staff cost to net interest income (NII) + all other income. Identification of weak banks 8. All the public sector banks were evaluated on the above seven parameters keeping the median as the threshold in five of the parameters. For capital adequacy ratio, the threshold was 8 per cent and in respect of the coverage ratio it was kept at 0.50 per cent. 9. Indian Bank did not meet any of the parameters in both the years. UCO Bank and United Bank of India could comply with the capital adequacy prescription but failed in all the other six parameters. These banks, along with Indian Bank, were the only banks to have received capital infusion during the last two years and would not have attained minimum capital adequacy otherwise. 10. The above approach serves the immediate objective of setting the criteria for identifying weakness in banks in general and for locating potentially weak banks. The Working Group, therefore, recommends building a database in respect of banks on an ongoing basis for the purpose of benchmarking and on that basis identifying signals of weakness. Causes of weakness 11. The causes of weakness need to be addressed properly so that the remedial measures adopted prove effective and actually succeed in improving the functioning of the weak banks. The weaknesses relate to three areas: operations, human resources and management. 12. Operational failures mainly relate to high level and fresh generation of NPAs, slow

decision making with regard to fresh sanction of advances and compromise proposals and loss of fund-based advances and fee income. Declining market share in key areas of operations, limited product line and revenue stream, absence of cost control and effective MIS and costing exercise, weak internal control and housekeeping, poor risk management and insufficient customer acquisition due to mediocre service, low level of technology and non-competitive rates are the other causes. 13. The operations of subsidiaries and foreign branches, which are a drain on two of the banks, lead bank and RRB responsibilities and locational disadvantages are also related issues. 14. Overstaffing, low productivity and a high age profile are the main HR related issues. Restrictive practices in deployment of staff have further aggravated the cost of overstaffing. In the three identified banks, staff cost as a proportion of total operating income has been above the industry median. Another area of concern is the level of skill and low levels of motivation. Skills in foreign exchange, treasury management and other specialised areas are not significant enough to generate business in these areas on a sustained basis. 15. Training facilities are not adequate to meet the training requirements of the staff of the banks and motivation and morale of employees at all levels is low. 16. Under management related issues, lack of succession planning, short tenures and frequent changes in top management, inadequate support from the Board of Directors and the lackadaisical implementation of earlier SRPs and MOUs are causes of weakness. Even after infusion of Rs. 6,740 crore in the three banks over the last seven years, their basic weaknesses persist. Unconditional recapitalisation from the Government of India has proved to be a moral hazard as no worthwhile attempt has been made by the banks to gain adequate good business or to reduce costs. Past efforts at restructuring 17. The restructuring efforts initiated so far have not had the desired impact. Hard options have been avoided and the steps taken so far have only had the objective of maintaining the capital adequacy ratio of the banks with the assistance of Government of India. The banks have failed to develop the required resilience or strength to become competitive in the true sense. Present position of the weak banks Indian Bank 18. Indian Bank continued to incur operating losses in 1998-99 also. The capital adequacy which had turned positive and reached 1.41 per cent in March 1998 with capital infusion of Rs. 1,750 crore from the Government of India turned negative again in March 1999. The decline in other income continued during 1998-99 as well. The bank did not make any provision for liabilities arising on account of the proposed wage revision. The deterioration on the NPA front is unabated. Gross NPA went up from Rs. 3,428 crore as on 31 March 1998 to Rs. 3,709 crore as on 31 March 1999, i.e., 37 per cent of gross advances. This was the highest among public sector

banks. UCO Bank 19. UCO Banks operating profit improved marginally in 1998-99. However, if the interest income on recapitalisation bonds is excluded, the bank would have incurred operating loss of Rs. 91 crore in 1997-98 and Rs. 157 crore in 1998-99. Recapitalisation by the government to the tune of Rs. 200 crore helped the bank achieve capital adequacy of 9.63 per cent in 1998-99. The bank has not made provision for liability on account of wage revision. Gross NPAs as on 31 March 1999 aggregated Rs. 1,716 crore (23 per cent). Net NPAs at Rs. 715.63 crore were higher as compared to Rs. 705 crore as on 31 March 1998. The inability of the bank to register any improvement in the net NPA position is a matter for concern. United Bank of India 20. United Bank of Indias operating profit decreased substantially in 1998-99. Operating income increased mainly on account of extraordinary income by way of interest received on income tax refund. Further, if the interest income on recapitalisation bonds is excluded, the bank would have incurred operating loss of Rs. 89 crore in 1997-98 and Rs. 117 crore in 1998-99. Recapitalisation by the Government of India to the tune of Rs. 100 crore helped the bank achieve capital adequacy of 9.60 per cent in 1998-99. The bank has not made provision during 1998-99 for future pension liability and wage revision. The gross NPAs of the bank as on 31 March 1999 increased in absolute terms to Rs. 1,549 crore (32 per cent) from Rs. 1,451 crore as on 31 March 1998 (34 per cent). Net NPAs also went up to Rs. 573 crore (15 per cent) as on 31 March 1999 from Rs. 472 crore (14 per cent) as on 31 March 1998. Assessment of revival plans prepared by the banks 21. The plans prepared by the banks at the Working Groups instance were no better than the earlier ones that had failed in that they continue to be based on ambitious projections of growth in business and income for which the banks are not equipped in terms of skill or technology. The plans do not reflect the growing compulsions of having to achieve steady growth in income and sustained control of expenditure within as short a time as possible. Therefore, the restructuring plans drawn up by the banks do not meet the objectives. It is felt that, as long as government assurance as to continued capital infusion is there, the banks would only look at soft options regardless of the time and cost involved. Future course of action 22. The restructuring exercise has to be comprehensive and must address operational and financial restructuring simultaneously. There is no room for half way measures or gradualism. It is tempting to confine restructuring to financial aspects since solvency is immediately restored and there is a visible impact on the balance sheet. But, if operational aspects are not attended to, long term sustainability cannot be ensured. This will only lead to additional problems necessitating further and costlier restructuring down the road.

23. Future restructuring strategies must incorporate the core principles of manageable cost, least burden on the exchequer, sharing of losses equitably and strong internal governance. There should be an independent agency that will constantly monitor the progress of restructuring. 24. Bank restructuring has been attempted mainly by using one or more of the following modalities: merger or closure, change in ownership, narrow banking and a comprehensive operational and financial restructuring. The Working Group has examined the applicability of each of the above options in the present Indian context. Merger or closure 25. Merger would be advantageous only if it takes into account the synergies and complementing strengths of the merging units. The Working Group does not recommend merger as a possible solution in reviving the weak banks without first preparing them for it. 26. Closure has a number of negative externalities affecting depositors, borrowers, other clients, employees and, in general, the areas served by the banks being closed. This is an extreme option and would need to be exercised after all other options of successful restructuring are ruled out. Change in ownership 27. Privatisation is an acceptable course as this process alone can reduce the governments responsibility of capitalising the three banks further and, in the long run, enable it to recoup, fully or partially, the investment made in their capital. This will remove the moral hazard implicit in the present situation that government support will always be available and make the three banks responsive to the rules of market economy. The three banks will then also have a sense of accountability to all the stakeholders and appreciate the need for good performance. 28. However, in their present state, it is just not possible to consider their privatisation because the cost of restructuring is prohibitively high and no private group can normally be expected to bring in the kind of resources that the three banks require at present. These banks are also not likely to succeed in accessing the capital market given their present position. Their present staffing pattern and level of skills and technology will be deterrents to any investor. Narrow banking 29. All the three weak banks have pursued some form of narrow banking, without success, for reasons such as inability to lend to quality customers, as a matter of deliberate policy, high levels of NPAs and fear psychosis. Preferring government securities to fresh lending creates dissatisfied borrowers who tend to change their bank. Banks ability to generate non-interest income is linked to the size and quality of their advances portfolio. A restriction on this results in a fall in fee income. Such a two-pronged loss in income adds to the weakness of the bank making its recovery even more difficult. Further, resorting to narrow banking does not protect a bank against all risks as even investments in gilts are open to market risks. In any case, narrow banking can at best be only a temporary phase and cannot by itself be adopted as a restructuring

strategy. Comprehensive operational and financial restructuring 30. With the three other options not being found suitable to the present environment, the only other option left for consideration is that of a comprehensive operational and financial restructuring. The Group has tried to answer the question whether this option of restructuring is available in the case of the three identified weak banks. 31. The three banks are obviously beset with serious weaknesses and have not been able to turn around despite repeated recapitalisations almost all through the 1990s adding up to a massive sum of Rs. 6,740 crore. They continue to depend upon the government for further recapitalisation and Indian Bank alone will need another Rs. 1,000 crore urgently to gain the prescribed minimum capital adequacy of 9 per cent with no guarantee that at the end of the current year, they will once again not need further infusion of capital to maintain this ratio. The position of the other two banks is only marginally better as they do not need capital infusion immediately. However, their future operations too are unlikely to continue without further infusion of capital. It does not, therefore, make economic sense to let them continue in the present manner for, after all, the government cannot undertake to capitalise them endlessly. 32. It is, therefore, time to take a long term view and ensure that the present state of affairs does not get prolonged. The choice is, therefore, limited to either closing them or subjecting them to such extensive operational, organisational and financial restructuring as can effectively restore their competitive efficiencies. 33. In view of the very extensive network and large client base of each of these banks, as also the other attendant negative externalities, closure is to be considered only as the last option. The choice of comprehensive restructuring, therefore, requires careful consideration. Any such restructuring, however, will mean exercising hard options and involve firm, decisive and timely actions. There must be a firm political will backed by firm commitments from the bank management and the employee unions that the restructuring exercise will be completed without any let up or hindrance. The management and employee unions of the banks will have to come to an agreement before the restructuring exercise begins as regards every important ingredient of the proposed exercise. The crux of the issue is that it is going to be an expensive one-time exercise and, unless its success is reasonably assured, it will not be worth undertaking. 34. Subject to what has been stated above, the Group has developed a four-dimensional comprehensive restructuring programme covering operational, organisational, financial and systemic restructuring. These are as under: 1. Operational restructuring involving i. basic changes in the mode of operations,

ii. iii. iv.

induction of modern technology, resolution of the problem of high non-performing assets and drastic reduction in cost of operations.

2. Organisational restructuring aimed at improved governance of the banks and enhancement in management involvement and efficiency. 3. Financial restructuring with conditional recapitalisation.

4. Systemic restructuring providing for, inter alia, legal changes and institution building for supporting the restructuring process. Operational Restructuring 35. In a well-researched document published by the IMF in 1997, one of its contributors, Gillian Garcia, has identified the following as key elements of operational restructuring: a. Formulating a business plan that focuses on core products and competencies. b. Reducing operating costs by cutting staff and eliminating branches where appropriate, ceasing unprofitable activities, and disposing of unproductive assets. c. Implementing new technology and improving systems of accounting, asset valuation, and internal controls and audit. d. Establishing and enforcing internal procedures for risk pricing, credit assessment and approval, monitoring the condition of borrowers, ensuring payment of interest and principal, and active loan recovery. e. Creating internal incentive structures to align the interests of directors, managers, and staff with those of the owners. The Working Group considers the above to be a very good and concise statement of operational restructuring requirements. The plan evolved by the Working Group for restructuring of the three banks is also on similar lines. 36. Operational restructuring for the weak banks is two pronged: one of increasing income and the other of reducing costs. Income has to be increased by revamping the banks mode of doing business and by reducing the effect of current and future NPAs on their earnings. Cost reduction will have to be achieved by dropping the lines of business and products that are proving to be a drag on their profitability and effecting reduction in staff costs which account for most of the operating costs incurred by the weak banks. Change in mode of operations

37. None of the weak banks is identified with any special business or customer niche. Each of them, therefore, needs to develop strengths in chosen areas and build its skills and business strategy around those strengths. By trying 12 to be all-India banks, they are neither any more dominant in the area of their concentration nor are they able to make a mark countrywide. 38. The growth of these banks credit portfolios has been extremely limited and their feebased earnings minimal. They need to take urgent steps to reintroduce credit culture and ensure a rapid growth in non-fund based earnings by laying stress on a few selected services, particularly, movement and management of funds. 39. These banks had left the traditional areas of business in which they had experience and moved into areas for which they neither had skills nor the experience and this has been their undoing. They need to go into areas in which they have the experience and can develop expertise in a short time. The appropriate markets for them will be the middle and lower segments of the credit market. 40. Unions have pleaded for allocation of a share of the PSU and other government departments related business. Such an approach is not practical nor is it desirable especially in the present deregulated environment where the banks need to stand on their own and where these bodies themselves are autonomous in their functioning. Foreign branches and subsidiaries 41. Both UCO Bank and Indian Bank would find it extremely difficult to run their foreign branches in the short and medium term. The position even now is tenuous and would get exacerbated if any of these operations runs into the slightest of difficulty or if the local regulators stipulate conditions regarding capital adequacy which the banks may not be able to meet. This could pose a problem for not only the three banks but also for the Indian banking system. These branches need to be taken off their hands by selling them to 13 prospective buyers including other Indian public sector banks. The resources raised could fund some of the various demands of the restructuring operations. 42. The subsidiaries of Indian Bank are likely to be a continued drag on its viability and would add to the cost of restructuring. A decision to close them needs to be taken at the earliest. An effort could also be made to find buyers for the banks holdings in the subsidiaries. Adoption of modern technology 43. Public sector banks, particularly the weaker ones, are losing ground and share of business to the technologically well-equipped new private sector as well as foreign banks. The weak banks do not have either the skills or the resources to implement and maintain complex IT solutions of the kind that are required to meet the challenges. A desirable solution would be to

have common networking and processing facilities. Such common facilities may be outsourced from an existing reputed company. The service provider could also be invited to follow a Build Own Operate Transfer model for this purpose. 44. Implementation of an IT solution in the above manner will, among other things, enable introduction of extended working hours and shifts and improve overall customer service. In the first stage itself, which may be spread over twelve to eighteen months, the IT solutions should target coverage of over 70 per cent of the participating banks present business. This would require that around 250 to 300 of the largest branches from each of the three banks be linked to the proposed outsourcing. The Working Group has estimated the total cost for this at Rs. 300 crore which may come by way of assistance from the government or from multilateral lending institutions. NPA management 45. NPAs have been the most vexing problem faced by the weak banks with additions to NPAs often outstripping recoveries. A significant portion of the NPAs are chronic and/or tied up in BIFR cases. There are also loans given to state and central public sector units which have failed to repay. The operations of Debt Recovery Tribunals are such that they have not so far made a dent in the NPA position of banks. The route of compromises has also not been very successful despite setting up of Settlement Advisory Committees. It is necessary that measures are found to ensure an early resolution of chronic NPAs. Where guarantees have been given by the central or state governments and where these have been invoked by the banks, these demands need to be met. 46. Separate institutional arrangements for taking over problem loans have played a key part in bank restructuring in different countries with varying degrees of success. The Committee on Financial System (1991) and the CBSR (1998) had made similar recommendations. Such separation of NPAs is an important element in a comprehensive bank restructuring strategy. 47. It would be desirable to develop a structure which will combine the advantages of government ownership and private enterprise. The broad structure would be that of a government-owned Asset Reconstruction Fund (ARF) managed by an independent private sector Asset Management Company (AMC). Assets belonging to public sector banks can be transferred to the ARF. The ARF will be constituted with the objective of buying impaired loans from the weak banks and to recover or sell them after some reconstruction or in an as is where is condition. The ARF may be set up by the proposed Financial Restructuring Authority under a special Act of the Parliament which while protecting it against obstructive litigation from the borrowers could also provide for quick and effective enforcement of its rights. The ARF may be required to acquire assets of the face value of about Rs. 3,000 crore. The capital needed by the ARF would be in the region of Rs. 1,000 crore. 48. The payment in respect of the assets purchased from the weak banks may be made by the ARF by issuing special bonds for the purpose bearing a suitable rate of interest. It may also be guaranteed by the government in order to improve its liquidity. The bonds may, however, be issued to the weak bank with an initial lock-in period of at least two years. These bonds as also

those which will be issued for raising funds against the security of assets purchased by the ARF may have a maturity of five years. 49. The ARF should purchase from the banks loans, which are NPAs as on a certain date, say, 31 March 2000. The responsibility of recovering loans, which become NPAs after that date should remain totally with the banks concerned. It will, therefore, be adequate for the ARF to have a life of not more than seven years. The ARF may buy NPAs only from the banks which have been identified as weak, though the option of buying loans from other banks should not be closed. It should be possible to set up more such funds later if the need arises. 50. The transfer price has to be fair to both the buyer and the seller. It would be difficult to prescribe rigid arrangements or a floor price for the transfer of NPAs and each case may have to be decided on merits. So long as pricing is arrived at by mutual agreement and in a transparent manner, the Group does not consider it necessary either to prescribe a floor price or a formula therefor. 51. The management of the ARF would be entrusted to an independent Asset Management Company, a private sector entity, which will employ and avail of the services of top class professionals. The AMC can be compensated for the services it provides in the form of service commission on the value of assets managed coupled with incentives for recoveries if these are higher than an agreed benchmark. 52. In the ownership of the AMC, while the government would have a fair, may be even dominant, share of up to 49 per cent, majority shareholding will be non-government. The other shareholders could be institutions like SBI, LIC, GIC, UTI and IFCI whose participation does not add to government shareholding and also parties from the private sector. The initial capital requirement of the AMC is not likely to be more than Rs. 15 crore and it would, therefore, not be difficult to attract non-government participants therein. It would also be possible to attract participation of multilateral agencies like IFC or ADB. The possibility of an existing Fund Manager, in public or private sector, offering to manage the ARF may also be explored. 53. To the extent that NPAs are taken off the books of the three banks and are moved on to the Asset Reconstruction Fund, the Fund would be paying them for the assets taken over by way of bonds bearing interest. This interest earning will add to the concerned banks income which to a considerable extent will help the bank in meeting their staff expenses. Assuming that NPAs will be transferred at a rate so as to bring them down to the average level of NPAs in PSBs which is around 15 per cent, the annual income for Indian Bank, UCO Bank and United Bank of India can be expected to be augmented by around Rs. 91 crore, Rs. 44 crore and Rs. 24 crore respectively. Reduction in cost of operations 54. Cost income ratio of the Indian Bank, UCO Bank and the United Bank of India for the year 1998-99 worked out to 141.22, 93.94 and 89.90 per cent respectively showing clearly that the cost of their operations has reached unsustainable levels and that, unless the situation is corrected immediately, survival of these banks could be in jeopardy.

55. The cost of operations of the three banks is clearly unsustainable and is threatening long term viability and survival of these banks. When it comes to cost management and reduction, non-staff expenses are far less critical than staff expenses. These comprise of expenses incurred on items governed by market conditions over which banks have little or no control. 56. Management of costs necessarily boils down to management of staff expenses which in the year 1998-99 accounted for 76.37 per cent and 80.60 per cent of the total operating income (NII + all other income) in UCO Bank and United Bank of India respectively. In the case of Indian Bank, the position was much worse at 107.79 per cent. Other similarly placed public sector banks have this ratio generally below 45 per cent. Banks which have to allocate a comparatively lower portion of their overall income towards their staff costs obviously have a tremendous competitive advantage over the others. 57. Since chances of increasing income in the short term are remote, the weak banks have little choice but to take all possible measures to reduce their staff costs and bring it in line with at least the average performing public sector banks in terms of its percentage to total operating income (net interest income + non-interest income). 58. The three banks have not factored in the wage revision that is to become effective from November 1997. No provision in respect of the increase (12.25 per cent) has been made and should it become applicable to them not only will the yearly wage bill for the future years go up but substantial amounts will also go towards arrears for the period beginning from the date from which the revision becomes effective. 59. With the added income from transfer of NPAs in the form of interest on the relative bonds, the requirement of staff reduction would get suitably modified and has been estimated to be of the order of 30 to 35 per cent in the three banks. Considering all factors involved, the Group is of the view that initially a reduction in the staff strength of the order of 25 per cent may serve the purpose and should, therefore, be aimed at. This reduction in staff strength would help the banks reduce staff costs correspondingly which going by the expenses incurred in the year 1998-99, would work out approximately to Rs. 107 crore, Rs. 121 crore and Rs. 85 crore in the case of Indian Bank, UCO Bank and United Bank of India respectively. 60. This step is unavoidable since continuing with the present strength could jeopardise the survival of the three banks. In order to control their staff costs, the three banks will have to resort to a voluntary retirement scheme (VRS) covering at least 25 per cent of the staff strength. It is estimated that a reasonable VRS for the three banks aimed at 25 per cent reduction would cost between Rs. 1,100 and Rs. 1,200 crore. 61. The rightsizing of staff will have to be achieved by the individual banks structuring their schemes in such a way that they are able to maintain the required balance between the different categories of staff and do not lose the desirable experience and skills they possess. The scheme will have to be voluntary but the right to accept or reject individual applications should rest with the management. The scheme should aim at separation of employees in the age group of 45 and above especially those in the 50-55 age group. The scheme should be in operation for a period

not exceeding six months. The banks will need to undertake considerable retraining and relocation of the post-VRS staff strength. Such reskilling and relocation should be made a precondition for future recapitalisation. 62. In order that the VRS and the needed reduction in staff costs have a real impact on the operating results of the banks concerned, it would also be necessary to place a cap on the staff expenses of the three banks. Towards this, the Working Group recommends that a freeze on all future wage increase including the one presently under contemplation, i.e., with effect from November 1997, be put in place. This may continue for a period of five years. 63. If VRS does not lead to the needed reduction in the banks operating costs, there will be no alternative left but to resort to an across-the-board wage cut of an order which will result in a similar reduction in costs. It is with this urgency in mind that the Working Group has suggested keeping the VRS open for a limited period of six months. 64. The only other source of sustenance in these cases is recapitalisation support from the government but this too is not readily available because of the increasing pressures and other compelling demands on the governments resources. If, therefore, the banks are to survive, most efforts and sacrifices will have to be their own. Outside support can only be limited and short term and will be predicated upon what the banks can do themselves. Organisational Restructuring 65. The complex administrative structure of the weak banks is a serious limitation impairing their decision making process. Each of these layers is delay laden and without any clarity of policies and purpose. Even though some delayering has been attempted in some banks, especially, UCO Bank, the administrative structure continues to be diffused. Delayering alone would not speed up decision making unless accompanied by clearly laid out policies and procedures, skills and adequate discretionary powers at the different levels of decision making. 66. The three banks have a larger network of branches than what their levels of business call for. There is also the question of concentration of branches in specific areas with which United Bank of India and UCO Bank are faced. There is an urgent need to consider rationalisation of branches in all the three weak banks. 67. The weak banks must take a hard and careful look at the branches the levels of business of which are below 50 per cent of the level of nationalised banks in similar area and after convincing themselves about their unviability decide to discontinue their operations By continuing such operations, hoping that these will improve in future or by showing them artificially as profitable using a transfer pricing mechanism which favours them unduly, the problem will be compounded and elude solution even in future. It, therefore, stands to reason that the banks merge two or more unviable operations into one viable operation. 68. Absence of dynamic leadership for long periods has been a major contributor to the consistent deterioration in the functioning of the three banks. There is a need for appointing CMDs who are especially suited to their jobs and are more in the nature of wartime generals

possessing special skills and attitude required for restructuring. They should have a sufficiently long tenure of, say, four to five years and should be in the age group of 50-52 years. In order to ensure uninterrupted progress of the restructuring plan and to commit the top management thereto fully, this tenure may not be ordinarily curtailed. The right persons for these jobs should be provided with incentives, both monetary and non-monetary, for achieving the restructuring mission successfully even if giving such incentives means making a departure from existing norms. If in the four or five year career of a person as CMD of a weak bank the bank shows a definite improvement, he could be considered for heading one of the prime banks/financial institutions in the country. 69. A line of succession should be developed well in time and a system put in place whereby, save exceptions, an ED would succeed the outgoing CMD. Excepting in very small banks, there should be two EDs. One of the two EDs could be responsible for driving the restructuring process leaving the CMD free to pursue other strategic growth issues. 70. The boards need to be reconstituted to include eminent professionals, industrialists and financial experts with the necessary training, experience and background. There should be a clear distinction between the roles of ownership, which the government has, and that of management, which it does not. The government may, therefore, consider withdrawing from the banks boards its own serving officers and replace them with independent nominees having relevant knowledge and experience. 71. Leadership is lacking in the middle levels of these banks because of inadequacies in skills both in the traditional areas of bank operations as well as in new and specialised areas such as credit, treasury operations, foreign exchange and IT. While a longer term training and reskilling programme will have to be undertaken, the banks would also need to resort to some recruitment in the senior and middle levels of management from the market. 72. The training facilities are inadequate to meet the needs that would arise following the restructuring efforts. These will have to be considerably strengthened. Training facilities created by more than one bank could be pooled for optimum utilisation of the limited training skills available. A sub-allocation out of the capital support earmarked for VRS may be made for reskilling and training. Financial restructuring 73. Financial restructuring has to be undertaken to ensure solvency. Capital infusion in the three identified weak banks has so far aggregated Rs. 6,740 crore. Further capital infusion in the case of Indian Bank is imperative to ensure its continued operations. Financial restructuring should aim at raising CAR to at least one per cent above the minimum required so that the banks can continue with their normal credit business. 74. To the extent immediate cash funds are not being made available, the present mode of recapitalisation by way of recapitalisation bonds may be continued. A portion of the additional capital requirement would need to be provided in cash in the form of either preference capital or long term subordinated debt. On this, the banks should have an obligation of giving a return.

Without this, they will fail once again to appreciate the necessity of developing minimum competitive efficiency and their obligation to service capital. Recapitalisation must be accompanied by strict conditions relating to operating as well as managerial aspects of the recipient banks working. Conditions should also apply to the manner in which these funds can be deployed. 75. Additional capital is required to meet the cost of (a) moving some portion of the NPAs out of the books, (b) cost of modernisation of technology, (c) HRD related costs including that of VRS, relocation and training and (d) capital adequacy. Funds required under (b) and (c) will have to come by way of cash. Requirements for items under (a) and (d), however, can be met through recapitalisation bonds as hitherto. Funds should become available only when the banks undertake the specific activities for which these have been earmarked. 76. Recapitalisation should be under an agreement, between the government on the one side and the banks Board of Directors, its management and staff and employee unions on the other, laying out the restructuring goals. The agreement, while stating clearly the extent of governments involvement and the responsibilities of the bank, should also contain details of the banks obligations to perform and report, precise milestones for performance and measures that will follow non-performance, treatment of NPAs and near term improvements in operating results. It would also be desirable to assign selected financial indices for the bank to follow within a timeframe. The performance under this agreement will have to be monitored closely. 77. The overall cost of restructuring the three banks over the next three years is estimated by the Working Group to be of the order of Rs. 5,500 crore. A purpose-wise break-up of the required amount is given below. a. b. c. d. Technology upgradation VRS NPA buyout For capital adequacy Rs. 300-400 crore Rs. 1,100-1,200 crore Rs. 1,000 crore Rs. 3,000 crore

The estimate could turn out to be inadequate if some hidden surprises surface or some delays or other roadblocks are encountered in the course of implementing the programme. Systemic Restructuring 78. In order to ensure success in restructuring of weak banks, Government of India should also consider setting up of an independent agency, say, Financial Restructuring Authority (FRA), to co-ordinate and monitor the progress of the programme. It will represent the owner, in this case the Government of India and, vested with due authority from the government, be able to give the banks undergoing restructuring, guidance and instructions for proper implementation of the programme including course corrections wherever necessary. It will approve bank specific restructuring programmes, enter into agreements with individual banks covering the terms and conditions of the programmes and follow up its progress with the bank and other concerned agencies. Among other things, it will also act as an owner of the Asset Reconstruction Fund on behalf of the government and ensure its proper governance. It would be desirable to set up such

an authority under an Act of the Parliament so that with the force of law behind it the FRA enjoys a distinct individuality. The FRA is not being conceived as a permanent body as it is expected that, with the completion of the restructuring process of the weak banks, it would have outlived the utility of its existence and would be wound up with the winding up of the ARF it will own. 79. It will facilitate the process substantially and help effective implementation of the restructuring programme if within the Reserve Bank of India, a special wing is formed for regulating and supervising weak banks. On a number of issues like deposit insurance, regulation of subsidiaries, risk management, disclosures and regulatory compliance, the treatment of weak banks would need to be different from those of much stronger normal banks. This arrangement would also help early detection of and attention towards weaknesses emerging in other banks pre-empting a systemwide spread of their problems. 80. Prolonged litigation prompted by legal lacunae in different commercial enactments is one of the main reasons for the increase in the size of the banks NPAs. Some of these enactments are several decades old and, in quite a few cases, out of line with the present day realities. These provisions need to be amended urgently and some new enactments are called for in order to cater to the requirements of the changed and far more complex current economic and business environment. 81. Countries like Thailand and Malaysia which have undertaken extensive bank restructuring recently have within a short period enacted amendments to their bankruptcy laws and improved provisions for foreclosures and court procedures to ensure speedier enforcement of lenders claims. Malaysia is also setting up specialised bankruptcy courts and steps have been taken there to plug loopholes that previously allowed borrowers to contract additional debts or dispose of their assets while restructuring was being worked out. Our problems are similar and it would be of great help to banks efforts in managing their NPAs if comparable laws are suitably enacted/amended urgently. 82. DRTs have helped the recovery process of the banks only in a limited manner. Their functioning is under review. Till necessary amendments to the Recovery of Debts Due to Banks and Financial Institutions Act, 1993, are made, steps should be taken to remove the administrative and infrastructural problems relating to the DRTs to improve and facilitate their effective functioning. Insofar as the recovery process of weak banks and the ARF is concerned, an arrangement may be worked out for the DRTs to attend to their cases on a priority basis. 83. The investigations into accountability both at the bank and at the level of non-bank agencies if completed in a time bound manner would go a long way in ending uncertainties and help in the overall improvement of morale of the staff. A time bound approach is absolutely necessary for creating appropriate conditions in banks in general and in weak banks in particular. Concluding remarks 84. The restructuring programme will have to encompass operational, organisational, financial and systemic restructuring and must be implemented in a time bound manner. Any

delay will add to the cost of the restructuring. The different measures suggested by the Group for financial, operational and systemic restructuring are a unified package and for results to be really achieved have to be implemented as such. A stage has reached when gradualism will not succeed and if resorted to may cause more harm than good. By adopting a pick and choose approach, not only a total effect expected from the package will be lost, but even the individual measures picked up for implementation would lose much of their efficacy.

Chapter 1 Introduction 1.1 Over the last several years, the Government of India and the Reserve Bank of India have been seized of the problem of weakness that has gripped some parts of the banking system. This weakness became apparent in the early 1990s when, following introduction of internationally accepted prudential accounting norms, banks were required to segregate their performing and non-performing assets and, after providing for those which are non-performing, build up a minimum level of capital related to risk-weighted assets. 1.2 Public sector banks have so far been able to meet their requirements of additional capital by infusion of funds by the Government of India or by accessing the markets. With the exception of a few, most public sector banks had to rely exclusively on the Government of India for their capital requirements. There have been some among them who have had to be provided with additional capital repeatedly. The quantum of such capital infusions by the government has often been quite large. 1.3 Save in a few cases wherein additional capital was needed to support the growing volume of business, the need for repeated capital infusion is on account of chronic weaknesses which, as discussed elsewhere in this report, have been caused by several factors, both internal and external. However, a stage has now been reached where further efforts at restructuring some of these banks cannot be confined merely to infusion of capital and giving certain targets for improvement in performance. One would necessarily need to look into their ability to achieve a minimum level of competitive efficiency in order that their operations become profitable on a sustainable basis. Any effort at their restructuring will have to involve operational as well as financial restructuring. Operational and organisational paradigms within which these banks are functioning will have to be revised and deficiencies that have got built into their working removed. 1.4 It was against the above background that the Reserve Bank of India, in consultation with the Government of India, set up the present Working Group under the chairmanship of Shri M.S. Verma, former Chairman, State Bank of India, and presently Honorary Adviser to the Reserve Bank of India, to suggest measures for revival of weak public sector banks. A copy of the letter dated 6 February 1999 addressed to Shri Verma in this regard is at Annex 1. The Working Group had the following members: i. ii. Shri K.R. Ramamoorthy, Chairman, Vysya Bank Ltd. Shri M.M. Chitale, Chartered Accountant (former President, Institute of Chartered Accountants of India). Shri P.K. Choudhury, Managing Director, Investment Information and Credit Rating Agency of India (ICRA Ltd.). Shri J.R. Prabhu, former Executive Director, Reserve Bank of

iii.

iv.

India. v. Dr. Sushil Chandra, former Director, International Management Institute, New Delhi.

Shri C.R. Muralidharan, General Manager, Reserve Bank of India, Department of Banking Operations and Development, Central Office, was the Member Secretary. 1.5 The terms of reference of the Working Group were as under: a. b. c. Criteria for identification of weak public sector banks; To study and examine the problems of weak banks; To undertake a case by case examination of the weak banks and to identify those which are potentially revivable; To suggest a strategic plan of financial, organisational and operational restructuring for weak public sector banks.

d.

1.6 The Working Group was expected to submit its report by 30 June 1999. The Group, however, felt that with the financial results of most of the public sector banks for the year 1998-99 becoming available by the end of June 1999, it would be desirable to analyse them, with particular reference to the position of their NPAs, and suitably adjust the restructuring strategies. Since one of the banks concerned could finalise its balance sheet only by the end of July 1999, the date for submission of the report had to be extended to the middle of August 1999 with the concurrence of Reserve Bank of India. Working Groups Methodology 1.7 The Working Groups method of work primarily comprised of a detailed examination of the published and other financial and operational data of all the public sector banks. For looking closely into the working, information/data was called for from all public sector banks and conclusions have been drawn on the basis of information received as also their balance sheets and other published figures. For recent data, the Group has relied upon data being collected by the Reserve Bank of India on an ongoing basis as part of its off-site monitoring of banks. 1.8 The Working Group sent questionnaires to the three identified banks eliciting certain information and their views on a wide range of operational issues. This formed one of the bases for the Working Group to formulate its views on the present state of health of these banks and possible strategies for their restructuring aimed at restoring their competitive efficiency. A copy of the questionnaire is given at Annex 2.

1.9 Since the work involved in the detailed examination of the functioning of the three clearly identifiable weak banks, viz., Indian Bank, UCO Bank and United Bank of India, was going to be quite voluminous and keeping in view the limited time available to it, the Working Group deemed it appropriate to constitute three sub-groups for studying each of the three identified banks. Each of the three sub-groups was assisted by a specialised agency with expertise and experience in studying problems related to weak units. Details of the constitution of the subgroups are given in Annex 3. 1.10 The sub-groups were required to pinpoint the causes of weakness and examine whether the three identified banks have the inherent ability and a viable plan to get over the problems and operate as banks with minimum competitive efficiency. The reports of the sub-groups, in a sense, form part of this report even though the Working Group, with a larger picture in view, has in some cases gone beyond their specific recommendations. The executive summaries of the three sub-group reports are given at Annexes 4 to 6. 1.11 The Working Group held a series of meetings among its members, with the sub-groups referred to above and with various senior officials of the Government of India, Reserve Bank of India and the three identified banks. It also met with and benefited from the views of a crosssection of people connected in various ways with banking. These included Chairmen/CEOs of Indian and foreign commercial banks and financial institutions, the Board for Financial Supervision, the Chief Vigilance Commissioner and a number of independent observers. A list of persons with whom the Working Group interacted is given at Annex 7. 1.12 The Working Group also met with, during various stages of its work, representatives of unions/associations. The representatives of the United Forum of Bank Unions also made a presentation to the Working Group. They gave their views as to the reasons for the present predicament of the weak banks and suggested what in their opinion could be the remedial measures. Outline of the report 1.13 Chapter 2 takes a look at the international experience with regard to bank restructuring insofar as they are relevant to the Indian context. An overview of the public sector banks, based on the findings of the Working Group, is given in Chapter 3. This chapter also discusses the definition of weak banks the Working Group has adopted and the manner in which it has been applied to identify the weak public sector banks. The factors contributing to weakness of the banks are delineated and discussed in detail in Chapter 4. The past efforts at restructuring these identified banks and the results thereof are discussed in Chapter 5. Chapter 6 goes into the present position of the weak banks based on the reports of the sub-groups and the financial results for the year 1998-99. The Working Groups recommendations regarding the restructuring strategy to be adopted for the three identified weak banks are detailed in Chapter 7. A summary of recommendations has been furnished in Chapter 8. Acknowledgements 1.14 The Working Group would like to place on record its appreciation of all support and

assistance that was provided to the Working Group by the Government of India, Reserve Bank of India, various banks and other institutions. The Governor and the Deputy Governors of the Reserve Bank of India were kind enough to spare their valuable time on more than one occasion to interact with the Working Group and offer it their wise guidance. 1.15 The Working Group also had the benefit of drawing from the deep insight, experience and expertise of several eminent persons who, as thinkers and practitioners connected with the world of banking and finance, shared their views with the Working Group. The Working Group is grateful to them for their valuable contribution. 1.16 The Working Group would also like to thank the CMDs, EDs, other senior officials and the respective officers and staff unions of all the three identified banks for their co-operation. Thanks are also due to the regional offices of the Reserve Bank of India at Calcutta, Chennai and New Delhi for their warm hospitality during the visits made by the Working Group and the subgroups. 1.17 The work of the sub-groups would not have been concluded in time but for the excellent service rendered to it by the three institutions identified to assist them. These institutions were ICRA Ltd. which assisted in the study of Indian Bank, SBI Capital Markets Ltd. for UCO Bank and CRISIL for the United Bank of India. In particular, thanks are due to S/Shri R. Raghuttama Rao, V. Sriram and N. Mahesh of ICRA Ltd., Kishore Gandhi, George Mathew, N. Shankar and Pathik Gandotra of CRISIL, and Ms. Anjali Gupta of SBI Capital Markets Ltd. 1.18 The Working Group received very valuable contribution from Shri C.R. Muralidharan, who was the Member Secretary, Ms. Sudha Damodar, Deputy General Manager, Shri G. Sreekumar, Assistant General Manager and Shri N. Badri Prasad, Assistant Manager, all from the Reserve Bank of India. Ms. Lakshmi Sundararajan, Private Secretary, Ms. Priya Raut and Ms. Beena Nair, also from the Reserve Bank of India, assisted the Working Group in its work. The Working Group would like to record its appreciation and thanks for the assistance rendered.

Chapter 2 Bank restructuring: international experience 2.1 During the last twenty years, over 130 countries, developed and developing, have experienced banking crises in one form or the other.1 Countries faced with such crises have tried to tackle them in their own ways. While some succeeded, others did not with the result that in successful cases the crisis could be controlled quickly and the cost to the country was fairly manageable. In cases where, for different reasons, the crisis handling was not effective, the adverse impact of the crisis was prolonged and the cost both in financial terms as well as in terms of human suffering turned out to be enormous. 2.2 The Working Group has made an effort to study the handling of banking crises in some of these countries and has also endeavoured to understand, the strategies adopted by them in the handling of the crises. The objective has been to learn, as far as possible, about the modalities of restructuring in these cases, the steps taken, the sequencing of such steps, the cost to the system in terms of finances and time, and the results achieved. Not surprisingly, from the study, a fairly consistent picture of causes as well as ingredients of successful handling of such crises emerges. Specific steps taken in these cases may have been different, and the institutions, existing or specially created as part of a restructuring strategy, may have been structured, funded and controlled differently, but the underlying objectives and the conditions which were sought to be created for overcoming the crises were by and large similar in most successful cases. 2.3 In the following paragraphs, a brief account of the crisis handling efforts of a few countries where the conditions were somewhat similar to ours is given. At the end of these accounts, an effort has been made to draw common conclusions and to see what lessons these contain for us. Sweden2 2.4 Sweden is an oft-quoted example of successful management of banking crisis by adopting a comprehensive strategy. Its banking problems came to light in late 1990 mainly due to over exposure to the real estate sector. The government opted for a comprehensive approach the main features of which were as follows: a. A separate restructuring authority, known as the Bank Support Authority, was set up. b. The government took steps to raise confidence in the countrys financial system. It guaranteed that the banks and all other credit institutions would meet their commitments as and when they arose. Along with this, transparency and disclosure of information ensured increased confidence at home and abroad.

c. The respective roles of all concerned agencies, the Ministry of Finance, the Riksbank, the Financial Supervisory Authority, and the Bank Support Authority were clearly defined. There was free exchange of information between these agencies.

d. On the basis of a clear yardstick based on capital adequacy and financial ratios, banks were divided into those which were viable and those which were not. The former category was eligible for financial assistance while the banks in the latter were to be closed or merged with other institutions.

e. The support agreements contained conditions relating to change in management and improvement of internal control and risk management systems. Owners equity was not guaranteed. This ensured establishment of proper incentives.

f. Structural reforms included strengthening of accounting, legal and regulatory frameworks and prudential supervision. g. Separate Asset Management Companies, Securum and Retriva, were set up respectively for Nordbanken and Gota Bank, the two institutions which received most of the budgetary support. These were solely funded and capitalised by the government. 2.5 Government support was in the form of capital infusion (86 per cent) and loan guarantees apart from share subscription or share purchases (10 per cent) and interest subsidies (2 per cent). The net fiscal cost to the budget was 4.2 per cent of GDP. This is being recovered by proceeds from sale of assets and by sale, at a substantial premium, of shares in the rehabilitated stateowned Nordbanken (with which the Gota Bank was subsequently merged). Poland3 2.6 Bank restructuring in Poland was also successful mainly because of its comprehensive approach. The strategy of the governments Enterprise and Bank Restructuring Programme (EBRP) was to make a proper assessment of the extent to which a bank was in trouble and then to emphasise organisational restructuring. For this purpose, the programme laid heavy stress on proper and transparent accounting and also provided for detailed audit by international auditing firms. 2.7 Privatisation was one of the main objectives of the restructuring programme. The banks to be restructured were, therefore, first transformed into joint stock companies with the government being the sole shareholder. To manage these banks in their new form, long term technical assistance contracts with reputable foreign banks (twinning arrangements) were entered into. 2.8 The government did not opt for centralised handling of bad debts by another agency since it felt that the bad debts must be recovered by the banks themselves. The banks were therefore recapitalised and the bad debts were left on their own books to be collected by them. 2.9 Since the loans were left on the books of the banks, there was the risk of further lendings to the defaulting borrowers. This risk was fore seen and duly covered by requiring the banks to make provisions for the loan and to set up debt workout units within a specified timeframe. The

debt workout units were also given a time limit within which they were to either sell or restructure the substandard loans. The whole programme was thus run with a firm time schedule. 2.10 A special legal framework was provided by the government for implementing the restructuring plan. Under the relevant law, i.e., the Restructuring Law of 1993, banks were debarred from extending fresh credit to bad debtors unless in conjunction with a restructuring agreement. The law required that one of the following events take place: (a) the loan is entirely recovered, (b) a restructuring agreement is entered into, (c) the debtor is legally declared bankrupt, (d) liquidation of the debtor is initiated or (e) the debtor has regained creditworthiness by servicing its debt for three months. If these requirements were not met, the bank was obliged to sell the loan in the open market. 2.11 The recapitalisation programme provided a one time substantial capital infusion to ensure that the bank could operate effectively and be suitable for privatisation. This recapitalisation was effected by issuing 15-year bonds, non-negotiable for three years, with biannual redemption starting 18 months from the date of issue. The non-negotiability and the delayed amortisation ensured that public funds were not misused. The Philippines4 2.12 The problems faced by banks in the Philippines in the early 1980s exemplify the special problems in dealing with government-owned banks. Due to non-transparent accounting practices, inadequate provisioning in loan losses and lax supervision, the banking sector in the Philippines was inherently weak. The Monetary Board, the supervisory agency, preferred to give the banks more time to tide over their crises rather than enforce regulation in respect of provisioning, etc. This supervisory forbearance resulted in making the banks position weaker. The weaknesses were exposed in 1983 when due to political turmoil and deteriorating balance of payments position, the government declared a moratorium on external debt repayment. This led to a crisis resulting in run on banks and capital outflows. The problem was compounded by the governments direction to banks to continue their lending to weak enterprises. 2.13 By end-1985, the Philippines National Bank (PNB) and the Development Bank of the Philippines (DBP) were declared insolvent. These banks accounted for nearly half of the banking systems assets. Their non- performing loans formed about 70 per cent of their combined portfolios and about 21 per cent of the banking systems assets. 2.14 The rehabilitation programmes adopted for these banks were comprehensive and included downsizing, transfer of non-performing assets to the Asset Privatisation Trust, recapitalisation, writing off of government deposits, introduction of new management, closing of branches and cost reduction programmes including significant staff cuts to the extent of nearly 25 per cent in PNB and 40 per cent in the case of DBP. As a result, the banks became much smaller; the total assets of PNB were reduced by 54 per cent and those of the DBP by about 87 per cent. By 1987, both banks returned to profitability and improved their capital asset ratios. In 1989, PNB was privatised up to 30 per cent and further to 57 per cent by 1996. 2.15 The success of the restructuring programme in the Philippines was that it addressed the

basic causes of weakness and that it encompassed financial and operational aspects. Such a comprehensive rehabilitation facilitated phased privatisation. Thailand5 2.16 Thailands financial sector had been facing problems since the early 1980s due to weak managerial practices and inadequate supervision. The remedial measures then taken included strengthening of the legal, regulatory and supervisory arrangements, government takeover, changes in management, mergers and closures and financial support at market-related rates. The basic weaknesses, however, persisted and, in 1997, deeper structural weaknesses in the economy brought these weaknesses to the fore again. 2.17 Immediate regulatory action involved suspension of operation of 58 finance companies, which were required to submit rehabilitation plans. The Financial Sector Restructuring Authority (FSRA) and the Asset Management Corporation (AMC) were created to aid the restructuring process. The FSRA was established as an independent body under a separate Act in October 1997 to review the rehabilitation of the suspended companies and, where rehabilitation was not feasible, to oversee their liquidation. 2.18 Legal reforms were also undertaken which included amendments to bankruptcy and foreclosure procedures to ensure orderly resolution of corporate debts. Regulation also was further tightened to bring accounting and classification of loans in line with international norms. 2.19 The FSRA assumed the responsibility of either rehabilitating or liquidating the troubled units. The most important point to note about the Thai financial restructuring programme has been that an entirely new institutional framework was created and the legal and regulatory framework was simultaneously amended to meet the requirements of the situation. It was thus a fairly comprehensive programme. Korea6 2.20 The Korean financial crisis that broke out in December 1997 had its origins in the corporate and financial sectors and a poorly implemented capital account liberalisation. The more immediate causes were a deteriorating terms of trade, bankruptcy of important chaebols (or conglomerates), and a change in international market sentiment. 2.21 Poor quality of regulatory control that did not provide for internationally accepted accounting and provisioning norms and had lax capital standards and generous exposure limits resulted in the banks building up large liquidity mismatches especially in their foreign exchange portfolio. This situation made the banking system extremely vulnerable to shocks. In 1996, when the terms of trade became adverse, the profit margins of Korean firms were affected. The failure of some bigger chaebols in 1997 and the East Asian crisis brought the situation to a head towards the end of 1997. 2.22 In November 1997, the government announced a blanket guarantee for deposits maintained with banks and other financial institutions. This helped retain the confidence of the depositors.

This was followed in December 1997 by a comprehensive reform package that included exit of unviable financial institutions, restructuring of others, and the strengthening of banking regulation and supervision. 2.23 The process of bank restructuring in Korea took the shape of voluntary mergers and foreign investments. Sizeable public funds were provided by the government to purchase NPAs and to recapitalise the banks. The funds were provided through the issuance of bonds by the two government bodies, the Korea Asset Management Corporation (KAMCO) and the Korean Deposit Insurance Corporation (KDIC) which was a new agency formed by merger of all deposit insurance protection agencies and also by purchase of shares, ordinary and preferred, purchase of subordinated debt, purchases of non-performing loans and repayment of depositors. 2.24 The bad loans were purchased by KAMCO at a discount that roughly corresponded to the mandated provisioning levels; the discount was then adjusted after KAMCO had a chance to have the collateral on the loans appraised. As this arrangement was not working satisfactorily, KAMCO later purchased the non-performing assets at a fixed price, 36 per cent of book value for secured loans and one per cent for unsecured loans based on historical estimates of loan recovery. 2.25 Supervision was placed with a new agency endowed with significant operational independence. This agency was also in charge of restructuring financial institutions. Regulations were tightened in the areas of risk concentration, connected lending, maturity and currency mismatches, cross guarantees, and in making financial statements more transparent. 2.26 The Korean crisis underlines the risks involved in supervisory forbearance and the importance of transparent financial statements so as to prevent the confidence of investors being undermined. It also highlights the importance of tighter regulation of on- and off-balance sheet risks and exposure limits. Supervisory forbearance allows problems to become larger and costlier to solve. The Korean experience also shows that where prudential norms are lax and transparency is lacking, the initial estimates of loan losses are likely to be unduly low leading to an underestimation of the resources that may be needed for bank restructuring. China7 2.27 Extensive bank restructuring is being carried out in China since 1997. Four of the largest state-owned banks, viz., Industrial and Commercial Bank of China, Construction Bank of China, Agricultural Bank of China and Bank of China, are undergoing restructuring programmes aimed at improving their efficiency and increasing profits which have stagnated due to huge nonperforming assets estimated to be at about 20 per cent of total outstanding loans. 2.28 The poor performance is attributed to decades of government- directed lending and poor management. Each of these banks reportedly has between 800 and 1000 branches and together employ more than 1.5 million employees. The operations are fully guaranteed by the central government, which owns them. 2.29 The series of measures taken by the government to improve management, capital and asset

quality include increasing banks independence from local governments, setting up asset management companies, conversion of debt into equity, mergers, closures and liquidation, and direct capital injections from the central government. Between 10 and 30 per cent of branches of these banks will be either closed or merged. A new board of supervisors for the banks will oversee the work of the top management of the four banks. This board will include representatives from the Peoples Bank of China, Ministry of Finance and the State Audit Office. 2.30 Reports indicate that the four banks will introduce wage reforms aimed at identifying qualified banking personnel and giving them better terms which may include higher pay, better housing and improved medical and retirement benefits. The surplus bank employees estimated to be between 10 and 20 per cent of total number of employees would be laid off. United States of America8 2.31 Bank failures in USA were comparatively few in relation to the total number of banks for almost the first 50 years since the setting up of the Federal Deposit Insurance Corporation (FDIC) in 1933. The 1980s and the early 1990s witnessed the most severe banking crisis since the Great Depression years. In this crisis, involving mainly the Savings and Loans institutions (S&Ls), or thrifts, over 9,000 institutions were either closed or merged. 2.32 The US banking system was highly segmented geographically and functionally, thereby increasing the risk profile of the banks. For instance, in 1987, 90 per cent of bank failures took place in states that still had restrictions on inter-state banking. Further, technological innovation and competitive pressures from credit card companies, money market mutual funds, insurance, securities houses and pension funds led to an erosion of the banks and thrifts traditional hold over the payments system, low-interest deposits, and commercial loans. Enhanced deposit insurance along with financial deregulation and growth in real estate construction fuelled by tax incentives, encouraged new entrants into the industry and led to higher risk- taking. Combined with poor management, imprudent lending practices and fraud, this led to an unprecedented crisis in the US banking system. The moral hazard effect of deposit insurance was strengthened when a number of large institutions, such as the Continental Illinois Bank were saved on the basis of the too big to fail principle. 2.33 Overlap between the jurisdiction of different regulatory institutions and regulatory forbearance further complicated the problem. The regulators, on account of budget cutbacks, reduced the strength of examiners and with it the quality and frequency of examinations. These factors delayed the diagnosis of the crisis and its resolution, the final cost of which increased several fold. One of the estimates of the final cost to the government for cleaning up the thrift industry alone places it at around US$ 150 billion. 2.34 In dealing with troubled banks, the FDIC mostly opted for the strategy of open bank assistance which involved preventive intervention before closure. This usually included assistance from the Federal Reserve in the form of emergency credits for temporary liquidity purposes. In the case of merger with healthier banks, FDIC entered into income maintenance agreements, where it stood guarantee for a minimum return on the earning assets that were acquired.

2.35 The FDIC strategy in respect of failing institutions was mostly by way of arranging for Purchase and Assumption (P&A) under which the acquirer purchased some or all assets and assumed some or all liabilities of the failed bank. In the case of clean bank P&As, only the good assets were taken over. When this proved to be a drain on its resources, FDIC opted for whole bank P&As where the entire assets and liabilities were taken over. When this became difficult to arrange for, small bank P&As were introduced where a smaller package of assets including some non- performing loans were taken over by the acquirer. By 1990, FDIC subjected all assistance to three criteria: competitive bidding, due diligence review by potential acquirers and quantitative limits on guarantee by it. 2.36 The crisis also resulted in a number of changes in the regulatory framework. The Competitive Equality Banking Act, 1987, provided for the establishment of bridge banks to take over the operations of a failing bank and maintain banking services for its customers. It helped bridge the gap between the failure of a bank and the time when the FDIC can implement a satisfactory resolution of the failing bank. This arrangement ensured that the banking needs of the normal customers and better borrowers are not affected. 2.37 The Financial Institutions Reform, Recovery, and Enforcement Act of 1989 allowed for placing temporary stewardship of problem banks with the federal authorities and in some cases allow for a temporary public equity stake when institutions are sold to the private sector. The FSLIC was liquidated and the FDIC took over insurance of thrifts. A new Office of Thrift Supervision was established to regulate thrifts. The Resolution Trust Corporation (RTC) was set up and given six years to clean up the assets of the thrift industry. 2.38 The RTCs two main roles were that of a conservator and receiver of the insolvent thrifts. As a conservator, the operations and employees of the thrifts under its charge came under its control until the best method of resolution was determined and implemented. The RTC could raise US$ 20 billion through general Treasury bond financing and contributions from federal home loan banks. It could also issue US$ 30 billion of special Resolution Finance Corporation bonds, using zero coupon treasury bonds as collateral. 2.39 The FDIC Improvement Act, 1991, among other things, provided for rules requiring regulators to act quickly (Prompt Corrective Action) when a banks core capital falls below 2 per cent of risk assets and to replace management and limit the asset growth of critically undercapitalised banks. It also provided for restrictions on the Federal Reserves ability to provide credit to ailing banks and introduction of differential deposit insurance premiums. Conclusion 2.40 In view of the pivotal role of the banking sector, banking problems need to be dealt with delicately. There is, however, no unanimity in the approach to resolution of banking crises. The responses to banking crises in various countries range from benign neglect or a policy of free exit to that of treating the sector or, at least a part thereof, as too big to fail. The latter approach is based on the perception that the failure of a big bank may disrupt the payments system and have a domino effect on other banks apart from causing distress to depositors and borrowers

alike. However, guaranteed protection to banks, whether explicit or implicit, is likely to generate or perpetrate behaviour that might lead to the very same kind of banking problems that such guarantees seek to prevent. Government ownership of these banks makes the situation more complex. 2.41 Restructuring of a banking system has to operate at two levels. The first needs to address macro systemic issues pertaining to factors responsible for ensuring banking soundness. These may include availability of a proper operating environment including legal and other institutional support, well-conceived internal systems and procedures, effective internal and external controls as well as regulation and supervision. 2.42 Tackling micro level, individual bank problems forms the second level. These broadly include resolving the banks problems at a financial and operational level. International experience has shown that attention needs to be paid to both financial and operational aspects to successfully restore solvency and ensure sustained profitability. Financial restructuring (micro level, individual bank issues) 2.43 Financial restructuring of a bank is mainly aimed at restoring its solvency. It involves one or more of the following: capital infusion, reduction of other liabilities, management of assets with a view to increase their value and other instruments aimed at increasing profitability. Capital infusion may take the form of additional capital contribution from the present owners or conversion of existing liabilities such as subordinated debt and even deposits into capital. Issue of fresh subordinated debt and government recapitalisation bonds are also other methods of improving the capital base. Operational restructuring 2.44 Operational restructuring attempts to provide the ideal conditions within a bank to ensure that the profitability increases and is sustained over a period. The key elements here are the quality of internal governance and the structure of a banks operations. The operational restructuring tools may include changes in ownership and management and a drastic reengineering of its operations to cover, among other things, its business strategy, product mix and pricing, loan recovery procedures, branch network, staff costs and increased resort to automation and other new technology. Systemic restructuring (macro level issues) 2.45 Systemic restructuring addresses the environmental issues such as the efficiency of the banking structure, ownership, entry and exit policies, distribution of banking assets, permissible activities, etc. The operating environment also includes the political, legal and other institutional infrastructure, the structure, quality and efficiency of which have a direct bearing on whether banking efficiency is promoted or hampered. 2.46 Different countries have opted for different strategies depending on the structure of their banking system. If banking assets are fragmented between different banks, consolidation by

merger will help achieve economies of scale and also economise on scarce managerial expertise. While healthier banks could be merged, consolidation could also be done by liquidating those that are insolvent. In the United States, thousands of banks and thrifts were merged or closed. 2.47 In a more concentrated banking system, large insolvent banks could be split, the viable parts sold and the rest liquidated. Breaking up of monolithic banking systems was adopted in several emerging market economies of Eastern Europe. In Nicaragua, Peru and Tanzania, large problem banks were downsized by placing restrictions on asset growth. In Argentina, Estonia, Latvia and Venezuela, several bigger banks were either closed or merged. Simultaneously, some of the countries permitted entry of new banks including foreign banks. 2.48 Privatisation of state-owned banks was found to have shown positive results. However, the mode of privatisation is important. If transfer is to individuals with inadequate banking experience or if the banks assets are poorly priced, further banking crises are likely to result. Privatisation will also enable the government to recoup the cost of restructuring, or at least a part thereof, if it has succeeded in restoring the bank to health and in greatly increasing its market value. 2.49 Establishment of what are variously termed as asset management companies or loan workout units and transfer of assets to them at market-related prices were found to be beneficial. Apart from improving cash flow, it enables the management to concentrate on the business of banking rather than waste efforts in chasing hard core non-performing assets. 2.50 While there is no unique solution to banking crises that could be prescribed and applied across the board to all countries, there are some common threads that seem to run through all cases of successful restructuring. Ultimately, each bank needs to be restored to a minimum level of solvency through financial restructuring. Thereafter, only longer term operational and systemic restructuring can help them maintain their competitiveness and enable them to ensure sustained profitability. Only a comprehensive approach to restructuring can have a lasting effect on the cost, earnings and profits of the banks to be restructured. Please see annex to Chapter 1 of Lindgren, Garcia and Saal (1996) for a concise survey of banking problems worldwide. See also Caprio and Klingebiel (1996a, 1996b), Hausmann and Rojas-Surez (1996), Honohan (1997), Sheng (1996) and Sundararajan and Balio (1991). 2 Drees and Pazarbasioglu (1998), Dziobek and Pazarbasioglu (1998). 3 Dziobek and Pazarbasioglu (1998). 4 Dziobek and Pazarbasioglu (1998), Nascimento (1991). 5 Bank of Thailand (1998a, 1998b) and Johnston (1991). 6 Balio and Ubide (1999), Bank of Korea (1998). 7 Leggett (1999), Ping (1999). 8 The Federal Deposit Insurance Corporation (1997, 1998), Sheng (1996).
1

Chapter 3 Public sector banks: an overview and identification of weak banks 3.1 Soon after independence, as India embarked upon planned economic growth, like any other country, it needed a strong and efficient financial system to meet the multifarious requirements of credit and development. To achieve this objective it adopted a mixed pattern of economic development and devised a financial system to support such development. The success it achieved, particularly in taking banking to the masses and making the banking system a potent vehicle for furthering public policy has few parallels in the world. 3.2 The rapid growth of the banking system in terms of presence as well as penetration over the two decades immediately following nationalisation of banks in 1969 was impressive. By the 1990s the public sector banks had 90 per cent share in the countrys banking business. By March 1992, all the public sector banks together had a phenomenal branch network of 60,646 branches spread across the length and breadth of the country and held deposits of Rs. 1,10,000 crore and advances of Rs. 66,760 crore. 3.3 Even as the banking systems branch network was growing at a fast pace, by the beginning of 1990s, it was realised that the efficiency of the financial system was not to be measured only by quantitative growth in terms of branch expansion and growth in deposits/advances or merely by fulfilment of social obligations of development. The financial strength and operational efficiency of the Indian banks and financial institutions which were working in a highly protected and regulated environment were not measuring up to international standards. The global and domestic developments called for corrections primarily with a view to strengthening the financial system and to bring it on par with institutions abroad. Hence, from 1992, a process of financial sector reforms, as a part of a broader programme of structured economic reforms was set in motion. Reforms and after 3.4 The financial sector reforms covered deregulation of policies, prescription of prudential norms based on internationally accepted practices in respect of capital adequacy, income recognition, asset classification and provisioning for impaired assets and introduction of competition in the banking sector. Several measures towards strengthening of supervision over banks were also introduced simultaneously. The prudential norms were adopted in a phased manner from 1992-93 to make the transition less painful. 3.5 Till adoption of the prudential norms, twenty-six out of twenty-seven public sector banks were reporting profits (UCO Bank was incurring losses from 1989-90). In the first post-reform year, i.e., 1992-93, the profitability of PSBs as a group turned negative with as many as twelve nationalised banks reporting net losses. The

remaining seven nationalised banks could show only marginal profits between Rs. 4 crore and Rs. 38 crore. As on 31 March 1993, only one public sector bank had capital adequacy ratio of above 8 per cent. By March 1996, the outer time limit prescribed for attaining capital adequacy of 8 per cent, eight public sector banks were still short of the prescribed level. The NPAs of the banks aggregating Rs. 39,253 crore as on 31 March 1993 brought the latent weaknesses in their asset portfolio out in the open. 3.6 The emphasis on maintenance of capital adequacy and compliance with the requirement of asset classification and provisioning norms has put severe pressure on the profitability of PSBs. Deregulation of interest rates on deposits and advances has intensified competition and PSBs have to now contend with competition not only from other public sector banks but also from old/new private sector banks, foreign banks and financial institutions. Above all, with the growth of the capital markets, sound corporate clients now have the option of raising funds at lower cost by accessing capital markets for their equity as well as debt requirements. 3.7 The response of the public sector banks to the above changes has been varied. While some have withstood all these pressures, for most, the shocks have been severe, at least, initially. The profitability of the public sector banks as a group remained negative in 1993-94. Despite improvement in 1994-95, there was a slippage again when the loss incurred by Indian Bank affected the profitability of the entire public sector bank group. However, there have been noticeable improvements since then and public sector banks, as a group, are now reporting profits. 3.8 The position in regard to profitability of PSBs from 1992-93 to 1998-99 is given in the table below: Table 1: Profitability of banks from 1992-93 to 1998-99 (Rs. crore) Net Profit/Loss 92-93@ 93-94 94-95 95-96 96-97 97-98 98-99 1,465 (8) 2,639 (17) 4,104 Nil (0) (-) 846 (2) (-) 846 3,258

Total Profit 280 356 846 1,023 1,650 2,460 (State Bank Group) (8) (8) (8) (7) (8) (8) Total Profit 115 375 895 1,196 2,124 2,965 (Nationalised banks) (7) (7) (11) (12) (16) (17) Total Net Profit 395 731 1,741 2,219 3,774 5,425 Total Loss Nil Nil Nil (-) 230 Nil Nil (State Bank Group) (0) (0) (0) (1) (0) (0) Total Loss (-) 3,688 (-) 5,080 (-) 625 (-) 2,360 (-) 679 (-) 398 (Nationalised banks) (12) (12) (8) (7) (3) (2) Total Net Loss (-) 3,688 (-) 5,080 (-) 625 (-) 2,590 (-) 679 (-) 398 Net Position for PSBs (-) 3,293 (-) 4,349 1,116 (-) 371 3,095 5,027 Note: Figures in brackets indicate number of banks. @: Excludes New Bank of India merged with Punjab National Bank in 1993. Source: Balance sheets.

Although as per the table only two banks recorded net loss as at the close of the year 1998-99 there is significant variation in the level of financial efficiency among the banks. It is also to be noted that good performance of some of the strong banks is neutralised by persistent underperformance of a handful of banks which are not improving enough and are, therefore, taking the shine away from the aggregate picture of PSBs performance. 3.9 There are some who would even like to debate whether performance of PSBs should be judged in terms of profitability alone. To them, fulfilment of social objectives of spreading banking services and spurring economic growth could well be taken as additional if not sufficient payback from PSBs. The Working Group does not wish to take any position in this regard. However, attainment of such social objectives as these banks were expected to follow, does not really stand in the way of their operating on profitable lines. Profitable performance recorded by most of them and more so the turnaround in profitability achieved by quite a few PSBs, goes to show that fulfilment of social objectives and profitability can and, in fact, need to go hand in hand. 3.10 Despite common ownership, bank specific efficiency levels vary and even among profit making banks there are wide variations in their respective abilities to maintain competitive efficiency and operate on profitable lines. Banks supported by strong non-financial factors such as leadership, skills, market awareness, good MIS and internal controls and effective strategy for countering competition have weathered the storm and exploited the opportunities provided by reforms and deregulation. 3.11 On the other hand, there are other banks which have failed to respond to the changes and have displayed weaknesses that have remained uncontrolled. It is not unlikely that the seeds of weakness latent in some public sector banks are not receiving attention. These need to be addressed squarely so that they do not, in the long run, pose a threat to the whole system. 3.12 A very important issue before the Working Group has, therefore, been to identify the factors responsible for the weaknesses developing in the first place. Explanations forthcoming after the weakness has taken hold are little more than post-mortems and seldom serve any worthwhile purpose. We need the ability to read the early distress signals and take urgent steps to control and eliminate the underlying causes of the distress. Criteria for identifying weakness 3.13 The issue of deciding on a set of criteria for identifying weak banks has been examined earlier and the Committee on Banking Sector Reforms (CBSR) headed by Shri M. Narasimham, has recommended that a weak bank would be one (a) (b) where accumulated losses and net NPAs exceed the net worth of the bank or one whose operating profits less the income on recapitalisation bonds has

been negative for three consecutive years. 3.14 The table given below shows banks which would get categorised as weak going by either of the two tests provided in the definition given by the CBSR. (a) Where accumulated losses and net NPAs exceed the net worth of the bank 31 March 1999 Allahabad Bank Indian Bank Indian Overseas Bank Punjab and Sind Bank State Bank of Indore @ State Bank of Mysore @ State Bank of Travancore @ United Bank of India

31 March 1998 Allahabad Bank Indian Bank Punjab and Sind Bank State Bank of Hyderabad @ State Bank of Indore @ State Bank of Mysore @ State Bank of Travancore @ United Bank of India

Note: @: These banks get included because of low capital base which needs to be augmented. UCO Bank gets excluded as the bank received capital infusion of Rs. 350 crore and Rs. 200 crore in 1997-98 and 1998-99 respectively. (b) Where operating profits less the income on recapitalisation bonds has been negative for three consecutive years 1996-97, 1997-98 and 1998-99 i. ii. iii. Indian Bank UCO Bank United Bank of India

3.15 The definitions of weakness prescribed by the CBSR lay stress on solvency and profit earning capacity of banks. In the opinion of the Working Group, these definitions are well considered and acceptable. The Group also believes that in order to identify a banks weakness or strength with some degree of certainty, it would be desirable to use a few more specific tests in conjunction with the two suggested by the CBSR. The Groups major concern has been not only to find a proper definition of weakness in banks but also to assess the extent of such weakness. A standard definition may enable one to categorise a bank as weak or otherwise on a given date. But, what is needed is some clear indicators which while giving an idea of the reasons that have led to the weakness will also enable us to judge a banks capability to earn profits on a continuing basis and also to withstand pressures on its capital in times of adversity. 3.16 The Group, therefore, selected seven parameters for assessing a banks strength/weakness covering three major areas, namely, (a) solvency, (b) earning capacity and (c) profitability. These are as under: Solvency

i. ii.

Capital adequacy ratio Coverage ratio

Earning capacity iii. Return on assets iv. Net interest margin Profitability v. Ratio of operating profit to average working funds vi. Ratio of cost to income vii. Ratio of staff cost to net interest income (NII) + all other income All the above ratios are well known parameters on which banks performance and sustainability are judged. A study of these ratios in respect of a bank, historically or in comparison with its peers will give a clear view of its growing strength or weakness over a period as also of its ability to compete against others in the market. 3.17 While all the seven ratios selected by the Working Group are considered equally important as they stress upon one or another critical aspect of a banks operations, in the context of studying weakness of banks, coverage ratio has an importance of its own and would, therefore, merit some elaboration. This is defined as the ratio of equity capital and loan loss provisions minus non-performing loans to total assets.9 Equity capital + Loan loss provisions Non-performing loans -------------------------------------------------------------------------Total assets Expressed in terms of percentage, this ratio shows the ability of a bank to withstand losses in the value of its assets. The merit of the coverage ratio lies in the fact that it allows simultaneous monitoring of two important elements, viz., (I) level of nonperforming loans and (ii) equity capital, adverse movements in which have been found to precede most cases of banking crises. Focusing on this ratio for identifying weakness of a bank is quite advantageous as it allows us to differentiate between banks which may have the same level of non-performing loans but different levels of equity capital and loan reserves. The differences in the latter could mean a wide difference in their comparative strengths and weaknesses. It thus gives due credit to the banks that have higher capital funds and have followed a more prudent policy of provisioning for their non-performing loans. 3.18 In the case of good, strong banks, this ratio would be higher bound and could go as high as the level of the capital adequacy required (8 to 12 per cent). As it declines and comes closer to zero, it shows the declining ability of the banks own resources, i.e., equity capital + loan loss provisions to cover for non-performing loans. Declining coverage ratio of a bank is thus a strong indicator of its fragility and susceptibility to distress.

3.19 The Group has also considered the question whether it should decide upon a threshold for coverage ratio below which a bank should be considered weak or in distress. In this context, it could be argued convincingly that the threshold for coverage ratio for banks in India should be high since the definition of nonperforming loans here is seen to be liberal compared to the definition generally used in banking systems abroad. It could be so also because the recoverability of such loans is not very high due to inadequacies in the extant laws and recovery procedures. 3.20 Given, however, that the present equity ownership of the public sector banks is largely with the government, the Group feels that at this stage a coverage threshold of 0.5 per cent for public sector banks should be acceptable. It would mean that these banks have available capital equity and reserves to the extent of 0.5 per cent of the value of their total assets for meeting any further loss in their value. Based on the financial results for the year ended March 1999, 13 banks had coverage ratios above this threshold. A comparative position is shown in Annex 8 B. 3.21 An attempt was made by the Working Group to assess and rank all the 27 public sector banks on the above seven parameters. A table showing their ranking is given at Annex 8 which gives a fair idea of their strengths and weaknesses. The rankings show that Indian Bank, UCO Bank and United Bank of India are among the weakest in all the banks ranked. 3.22 Use of the aforesaid additional parameters helps one to see clearly weakness of a bank as it gets reflected in the erosion of its net worth. These parameters also bring into sharp focus the incapacity of a bank to maintain a positive balance between its income and expenses and to do business on competitive terms. The Group, therefore, is of the opinion that the tests provided in the CBSR report supplemented by an analysis of performance based on the seven parameters detailed above, should serve as the framework for identifying weakness in banks in future. Identification of weakness in banks 3.23 The Group has looked at all the twenty-seven public sector banks in order to identify signs of weakness in them. Such an exercise is important as weaknesses which have not become quite manifest in some banks are, at present, covered or compensated by some countervailing strength. The identification of signals of latent weaknesses in these banks would help them initiate timely action and stop the problem from becoming chronic. 3.24 The seven parameters mentioned in paragraph 3.16 are being used to identify weakness or strength of a bank. By the same token, these parameters can also be used to evolve benchmarks for competitive levels of performance by public sector banks. In the opinion of the Working Group, to begin with, these benchmarks should appropriately be the median levels of ratios relating to these parameters obtaining in the 24 public sector banks (excluding Indian Bank, UCO Bank and United Bank of India).

3.25 The Working Group recognises that the benchmarks evolved with reference to the performance of the 24 public sector banks do not necessarily represent the most desirable levels of performance or the highest goals which a bank needs to set for itself. However, these are levels which if not achieved could clearly spell trouble for the bank in question. These are, so to say, minimum levels of efficiency, which need to be achieved for remaining competitive and maintaining longer term viability. Failure of a bank to achieve these minimum levels of efficiency should be seen as a warning signal which if not attended to urgently would turn these banks into weak banks. Quite clearly, banks performing even below the median of the levels achieved by all their peers will not be able to compete with any of those whose performance levels are higher than the median. It needs to be kept in mind that competition to public sector banks is not only from their peers but also from the new private sector banks and foreign banks whose comparative levels of performance judged on the same parameters are in most cases higher. Benchmarks set at the median levels of performance of public sector banks are, therefore, only the initial benchmarks which these banks need to set for themselves. Gradually, these will have to be raised to be able to meet the compulsions of competition. Findings of the Working Group 3.26 The Working Group has evaluated the position of the 27 public sector banks on the above parameters for the financial years ended 31 March 1998 and 31 March 1999. The basis for evaluation was: a. a threshold level of 0.50 per cent in respect of the coverage ratio. b. capital adequacy ratio of 8 per cent for both the years. c. the median level of the other five efficiency parameters for the respective years. The comparative position of the 27 public sector banks in this regard for the years ended 31 March 1998 and 31 March 1999 is shown in Annex 8. 3.27 The Working Group observed that based on the above analysis, public sector banks could be classified in terms of their strengths or weaknesses under three broad categories. Category 1: Banks where none of the seven parameters are met Category 2: Banks where all the parameters are met Category 3: Banks where some of the seven parameters are not met Category 1: Banks where none of the parameters are met 3.28 Evidently banks under this category are the weakest and where symptoms of weakness have already emerged. Indian Bank appears in this category in both 1998 and 1999. The Group observed that UCO Bank and United Bank of India, which have been identified as weak banks on their past record of losses could comply with the capital

adequacy prescription but failed to attain all the other six efficiency levels. The Group has noted that infusion of capital by the Government of India was confined mainly to the above three banks during 1997-98 and 1998-99, as the other banks have been able to generate adequate resources internally and reach the level prescribed by RBI. 3.29 The poor operational results of these three banks have, however, shifted the responsibility of maintenance of CAR to the government. The Group recognised that compliance of CAR by these two banks was possible only due to infusion of capital of Rs. 550 crore in the two years in the case of UCO Bank and Rs. 300 crore in the same period for United Bank of India. However, in the case of Indian Bank, the deficit from the minimum CAR level was too wide to be bridged and the bank could manage a positive CAR of only 1.41 per cent despite receiving a massive infusion of Rs. 1,750 crore in 1998. The bank ended up with negative CAR in 1999 despite receiving Rs.100 crore as additional capital during the year. 3.30 It is the considered view of the Group that achievement of capital adequacy entirely through capital infusion by the owner cannot be deemed as characteristic of a banks ability to reach minimum competitive efficiency. In the above background, the Group concluded that the above two banks also would have to be treated as weak banks on par with Indian Bank. 3.31 The malady of all the three banks appears to be deep rooted. UCO Bank and Indian Bank have been incurring operating losses, through the last three years. United Bank of India which was in a similar position, recorded operating profits only in 1998 mainly due to a windfall income of Rs. 111 crore by way of interest received on income tax refund. 3.32 These three banks are now trapped in a vicious circle of declining capability of attracting good business and increasing need for capital support from the government. Their situation primarily is an amalgam of slippage in capital adequacy, low levels of interest income, diminishing margins, increasing cost of operations and falling market share. In sum, they are unable to perform with minimum competitive efficiency. Hence, the above three banks are to be deemed as the weakest, among the group of public sector banks, which need immediate restructuring. Category 2: Banks where all the parameters are met 3.33 The following banks met all the parameters identified by the Working Group as tests of competitive efficiency. 31 March 1998 31 March 1999 Corporation Bank Oriental Bank of Commerce Dena Bank State Bank of Patiala Oriental Bank of Commerce State Bank of Patiala Category 3: Banks where some of the parameters are not met

3.34 Besides the three banks which are to be treated as weak banks, four banks in the year 1997-98 and only two in 1998-99 were able to meet all the parameters. Based on the performance levels achieved in 1998 and 1999, the remaining banks were grouped further based on the number of parameters they failed to meet. (a) Compliance with CAR and non-compliance with five or six of the remaining efficiency parameters 31 March 1998 31 March 1999 Allahabad Bank Allahabad Bank Central Bank of India Central Bank of India Indian Overseas Bank Indian Overseas Bank Punjab and Sind Bank Punjab and Sind Bank Syndicate Bank Union Bank of India Vijaya Bank Vijaya Bank The Group observed that except for Syndicate Bank and Union Bank of India, the remaining five banks functioned below the required level of efficiency in both the years, typifying the persistence of causes that would eventually manifest in weakness. In the opinion of the Group, these banks were showing strong signs of distress and run high risk of slipping into the category of weak banks. They are vulnerable to sudden changes that could arise in the external environment. The Group noted that Syndicate Bank had shown improvement in 1998-99, as they were able to achieve a higher return on assets. However, it is also noted that during the year the bank was able to register additional income due to changes in method of valuation of current investments and writing back of excess provisions made earlier. The bank has also chosen not to make any provision for NPAs during the year. It continues to have adverse ratios relating to management of costs and, any unfavourable business development, which could deplete incomes, may pose serious problems unless in the meantime the ratios have been corrected. (b) Compliance with CAR and non-compliance with three or four of the remaining efficiency parameters 31 March 1998 31 March 1999 Andhra Bank Andhra Bank Bank of India Bank of India Bank of Maharashtra Bank of Maharashtra Canara Bank Dena Bank State Bank of Indore State Bank of Bikaner and Jaipur State Bank of Mysore State Bank of India Union Bank of India State Bank of Mysore State Bank of Travancore State Bank of Travancore Syndicate Bank

The above banks may not be deemed to be in distress, but their efficiency levels call attention to their potential weaknesses which could emerge over time. Early solutions would help them to shake off their weaknesses. A point of concern is the increase in the number of banks falling in this category in the year 1999. (c) Compliance with CAR and non-compliance with one or two of the remaining efficiency parameters 31 March 1998 31 March 1999 Bank of Baroda Bank of Baroda Punjab National Bank Canara Bank State Bank of India Punjab National Bank State Bank of Hyderabad Corporation Bank State Bank of Bikaner and Jaipur State Bank of Hyderabad State Bank of Saurashtra State Bank of Indore State Bank of Saurashtra The above banks are fairly well placed to tackle the visible pointers to weaknesses through internal strategies.

3.35 The Group is of the opinion that the approach outlined in the above paragraphs is simple but effective and serves the immediate objective of setting the criteria for diagnosing weaknesses in banks in general and for identifying the potentially weak banks. It, therefore, recommends building up of a database in respect of banks on an ongoing basis for the purpose of benchmarking and, on the basis thereof, identifying signals of weakness.
9

The discussion on coverage ratio is based on Gonzlez-Hermosillo (1999).

Chapter 4

Causes of weakness
4.1 The Working Group has directly and, through the sub-groups constituted by it, gone into the causes of the three identified banks, viz., Indian Bank, UCO Bank and United Bank of India, becoming weak. These causes need to be addressed properly so that the remedial measures adopted prove effective and actually succeed in improving the functioning of these banks. The weakness identified by the Working Group relate to the following three main areas: a. Operations b. Human Resources c. Management These are discussed in detail in the following paragraphs. Operations Lack of a realistic strategic plan of action 4.2 Unrealistic assumptions have been behind plans and projections made in respect of critical aspects of the banks operations such as reduction of NPAs, recovery, creation of fresh NPAs, generation of non-interest income, etc. Under most of these heads the performance of the banks has been wide off the projections made. Share in business 4.3 In spite of their weak bank image, these banks are able to garner deposits obviously because of government ownership, deposit insurance and the public perception that government support would always be available. However, as may be seen from Annex 9, they are slipping in other key areas of their operations. Investments are replacing advances, particularly remunerative advances, and income from non-fund based business is not growing or is growing very marginally. The capability of these banks to do full range banking business in a manner that would result in a healthy bottom line is, therefore, being further impaired. It may be added in this context that with a much higher share in the number of branches these banks are not able to attract corresponding share in business even after providing for the fact that total share of income earned by public sector banks as a class did not correspond with their number of branches. Limited product line and revenue stream 4.4 Another cause of weakness is the lack of any well thought out strategy to improve their product line. The existing products are also not being marketed effectively. As a result, these banks are operating almost entirely on a single revenue stream, namely, interest income. Here too, they are unable to meet the pricing offered by their competitors both in respect of liabilities as well as assets.

Over dependence on interest income alone is impacting their earning capacity very adversely in a falling interest rate scenario. The banks also do not possess the required capability to manage interest rate related risks which makes sustainable viability of their operations even more suspect. High NPA and high fresh NPA generation 4.5 The position with regard to the level, recoveries and fresh generation of NPAs is given under Annex 10. All the three banks have built up a high level of NPAs over the years. Further, although UCO Bank was able to keep addition to NPAs lower than recoveries made in the years 1997-98 and 1998-99, in the other two banks, fresh generation of NPAs has been higher than recoveries. In UCO Bank also, the size of addition has still been quite large and, as a result, there has not been much improvement in the overall size of NPAs in the bank. This is mainly due to poor appraisal skills and non-upgradation thereof to keep up with the changes in the market environment and deregulation in various credit-related areas. Some of the credit decisions, especially in the case of Indian Bank, are allegedly cases of misfeasance. These are under investigation by various agencies including the judiciary. The high level of NPAs has affected their ability to recycle funds and has resulted in lower return on assets as also low net interest earnings. Slow decision-making process resulting in loss of business 4.6 The problem of NPAs is compounded by the fact that decision making in respect of both sanction of fresh advances and disposal of proposals for recovery of bad loans through compromise has been very time consuming. This has greatly contributed to the slowdown in sanction of fresh credit although it is also partly due to a conscious decision to park funds in government securities rather than in advances. The banks have also been excluded from several consortia partly on account of the slow decision making process, overpricing, poor services and an overall poor image. Slow growth and loss of fund-based advances leading to fall in income from nonfund based business 4.7 As a result of the negligible growth in advances, the banks share in business has suffered. These banks have been growing at levels far below the industry growth rate. Consequently, income from fee-based activities such as remittances, forex business, guarantees and LCs, which is already at a low level in these banks, is diminishing further. The banks have failed to develop alternative non-interest, fee-based sources of earnings. Indifferent customer service, lack of skills, and unwillingness to innovate and customise products/services as per the customers/markets expectations have been the main reasons for their failure to nurse their fee-based income. From some areas of remunerative business, e.g., forex transactions, these banks have been almost wiped out. United Bank of India, a bank with over 1,300 branches could earn from its forex transactions only Rs. 8 crore in the entire year 1998-99. The banks earnings from this source have been virtually stagnant at the level over the past three years.

Absence of cost control 4.8 In the absence of avenues for growth in income, cost cutting measures assume significance in any effort to regain profitability. However, as may be seen from Annex 11, costs, particularly overhead costs, are very high and are proving to be uncontrollable. These have already exceeded or almost exceeded the entire revenue earnings (net interest income plus other income) in these banks. While the chances of the revenue earnings growing at a good pace are extremely limited, the overhead costs continue to grow relentlessly. Absence of worthwhile MIS and costing exercise 4.9 What compounds the problem further is that the three identified banks do not have any worthwhile costing exercise, nor is there any MIS which can help such an exercise. Available information indicates that the margin between cost of funds and net average yield is extremely thin and may be difficult to sustain. Therefore, unless these banks are able to initiate drastic cost cutting measures, falling net interest margin and the resultant restrained growth in their net interest income can make their revival an even more distant hope. Poor management of risks 4.10 At the back of most of the problems discussed above is the fact that the identified banks have not put in place any risk management mechanism. As a result, they are exposed to every conceivable credit and market risk. In the absence of adequate systems and skills to identify existing and potential credit risks, slippage in performing assets is very likely. Further, the increasing shift to investments in government securities resorted to by weak banks in the last few years for deployment of resources could expose the banks to interest and market risks and serious maturity mismatches. Poor customer acquisition 4.11 Customer service in these banks is perceived to be as of poor quality. This is due to a weak administration and, as discussed below, lack of IT orientation in their operations. Partly because of this and the non-competitive rates offered by these banks, remunerative clients are severing or restricting relationship and new such clients are not coming. This is a vicious circle that these banks seem unable to break with their existing systems and work culture. Lead bank and RRB responsibilities 4.12 All the three banks have lead bank responsibilities in various districts. Moreover, UCO Bank and United Bank of India have both sponsored 11 Regional Rural Banks (RRB) each while Indian Bank has sponsored four. The RRBs sponsored by UCO Bank and United Bank of India had accumulated losses of Rs. 263.30 crore and Rs. 437.77 crore respectively as at the end of March 1999. Apart from contribution to initial capital and pro rata contribution to subsequent financial assistance, the sponsor banks also provide refinance at concessional rates apart from providing their own staff as chairmen and other senior officials. Further, the sponsor

banks also provide training facilities and incur costs in monitoring the activities of the RRBs. Though these are not accurately quantified, RRBs are definitely a burden on the sponsor banks resources. Locational disadvantages 4.13 Concentration of branches in the Eastern and North-eastern regions has been a factor inhibiting the growth of the United Bank of India and the UCO Bank. In the case of the former, such branches constituted 87 per cent of its branch network while, in the case of the latter, it was 43 per cent. Over concentration of a bank in any region makes it susceptible to the changes in the economic fortune of that region and demands a much greater degree of flexibility and adaptability in its operating strategies. The two banks have, unfortunately, not been able to show such adaptability in their strategies. In the case of these two banks, their predominant presence in the East and Northeast has, therefore, been disadvantageous to them. Role of subsidiaries 4.14 Indian Bank has three subsidiaries in the areas of housing, mutual fund and merchant banking, namely, IndBank Housing Ltd., IndFund Management Ltd. and IndBank Merchant Banking Services Ltd. The total investment in the subsidiaries is about Rs. 121 crore. The bank is likely to incur further losses on account of the poor functioning of its subsidiaries. For instance, the bank will have to fund the mutual fund to the extent of Rs. 79.54 crore towards schemes where indicative returns have been committed by the fund. An amount of Rs. 42 crore invested by the housing subsidiary in the ICDs issued by the banks borrowers is likely to devolve on the bank. Inability to upgrade technology 4.15 Given the change in environment towards a market-driven competitive economy, technology plays a major role in improving customer service, retaining market share and ensuring profitability. The level of technology available in these banks is mainly confined to the installation of ALPMs, PCs, etc. In the case of United Bank of India, only around 10 per cent of the branches have any form of computerisation. Indian Bank is, however, comparatively better off in this regard. At a low level of technology support, these banks would steadily lose business to other public/private sector banks providing high quality and speedier customer service. Lack of internal control resulting in poor housekeeping 4.16 As a result of the above factors such as lack of computerisation, poor MIS, frequent changes in management, etc., internal control and housekeeping have suffered. This has also acted as a deterrent to acquisition of new business at many of their branches. Human resources 4.17 The details of staff strength for the three banks are given below:

Table 2: Break-up of total employees as on 31 March 1999 Name of the Bank Indian Bank UCO Bank United Bank of India Source: Balance sheets. Adverse age profile of staff 4.18 The average age profile in all the three banks is on the higher side. In the United Bank of India, the average age is above 45 years with most of the managers in the middle and junior management levels being above 50 years of age. In a fast changing environment where business practices are becoming more complex, new products are being introduced and advanced technology is becoming a way of life, the ability of the employees to adapt to this new environment and acquire skills to function effectively in that environment assumes great importance. Low productivity 4.19 The Working Group has tried to make an assessment of productivity levels of banks. For this, business per employee is the yardstick presently used in the industry. Though this ratio has certain inherent deficiencies, the Group has gone by it for want of a more precise indicator. The relative position of the identified banks as well as other banks with regard to their business per employee is shown below category-wise. Table 3: Business per employee (Rs. crore) 1996-97 1997-98 Public sector banks Old private banks New private banks Indian Bank UCO Bank United Bank of India Source: Bank returns 0.66 0.96 5.54 0.70 0.42 0.57 0.76 1.15 6.64 0.75 0.48 0.65 1997-98 Highest Lowest 1.19 0.48 1.59 0.50 17.45 3.58 Officers 9,280 8,437 5,701 Clerical 13,423 16,739 11,022 Sub-staff 4,024 6,910 5,034 Total 26,727 32,086 21,757

4.20 The three identified banks show lower than average industry level productivity of staff. Even in a few one to one comparisons of business and staff levels, the identified banks appear much worse off than others. For instance, for the year 1998-99, the business level of Allahabad Bank at Rs. 19,885 crore (average deposits plus advances) was higher than that of UCO Bank at Rs. 18,044 crore. The nature, spread and quality of business are more or less similar. However, UCO Bank has over 9,000 more staff than Allahabad Bank.

Excess staffing 4.21 The above position is indicative of the fact that staffing in some banks has been more liberal and that the present level of staff is more than what the type and size of business handled by these banks can justify. Such excess and quite often lopsided staffing is seriously affecting their cost of operations and, ultimately, the bottom line. 4.22 The restrictive practices in deployment of staff have further aggravated the cost of overstaffing. Consequently, latent business opportunities at advantageous urban/semiurban/rural centres have remained untapped while over-manned establishments at metro centres continue to make operating losses. 4.23 An examination of the relationship between the total income earned by a bank and the staff cost it incurred for earning that income would provide a good measure for judging the payback from the staff cost incurred. It would also indicate clearly how well or ill placed the concerned bank is to bear that cost. A table showing the ratio of staff costs to total income (total interest plus non- interest income) for all public sector banks is given below. Table 4: Ratio of staff costs to total income (1998-99) Sr. No. Name of the Bank Percentage of staff costs to total income 10.59 10.61 14.79 15.65 16.42 16.54 16.56 16.74 17.22 17.89 18.07 18.52 19.76 19.87 19.95 19.98 20.40 20.83 21.41 22.26 22.89

1. 2. 3. 4. 5. 6. 7. 8. 9. 10. 11. 12. 13. 14. 15. 16. 17. 18. 19. 20. 21.

Oriental Bank of Commerce Corporation Bank State Bank of Travancore Bank of Baroda Union Bank of India Canara Bank State Bank of Patiala Dena Bank Punjab and Sind Bank Bank of India Allahabad Bank State Bank of India State Bank of Hyderabad Vijaya Bank Indian Overseas Bank Andhra Bank State Bank of Indore State Bank of Saurashtra Punjab National Bank United Bank of India Central Bank of India

22. 23. 24. 25. 26. 27.

State Bank of Mysore 22.99 Indian Bank 23.40 State Bank of Bikaner & Jaipur 24.24 Bank of Maharashtra 24.31 Syndicate Bank 25.00 UCO Bank 25.74 Median @ 19.14 @: Excluding Indian Bank, UCO Bank and United Bank of India. Source: Bank returns.

As would be seen from the above table, in the three identified banks, staff cost as a proportion of total operating income has been above the industry median level. Low skill levels 4.24 Yet another area of concern is the level of skill in all the three identified banks, which is rather low. Promotion policies have predominantly favoured seniority over merit. There is also no practice of lateral intake of specialised staff. This has led to low levels of motivation and skill. Skills in the areas of foreign exchange, treasury management and other specialised areas are not significant enough to generate business in these areas on a sustained basis. The emphasis on preventing incidence of NPAs has seen a reduction in or near absence of exercise of sanctioning powers at the lower levels. As a result, whatever skills for credit appraisal that were there are also getting eroded. Lack of motivation 4.25 Prolonged slowdown in business, adverse comparison with stronger banks and high NPAs have affected the morale and motivation of employees at all levels. This and fear of accountability for bad loans have almost killed every initiative for doing fresh business. Because of the managements continued failure to provide strong leadership and direction, staff unions have arrogated to themselves many management decisions relating to transfer, placement and even promotions, giving rise to a large number of restrictive practices. Training 4.26 The training facilities of the three identified banks are not adequate to meet the training requirements of their staff strength. As a result, the periodicity of training is only once in several years even for officers. There have also been instances of employees turning down training opportunities which may be attributed to the higher age profile, lack of motivation and infrequent transfers. Management Lack of succession planning 4.27 There has been virtually no succession planning in all the three banks inasmuch as senior functionaries are not groomed to take over responsibilities in the same bank at the top as an ED or CMD. As a result, the incumbents in the posts of General Managers and ED do not always identify themselves with the bank to the extent that they

would have, had they been in the line of succession for the top most positions within the same organisation. Short tenures and frequent changes in top management 4.28 Short tenures and frequent changes at ED/CMD levels have compounded the above problem. There have also been instances, especially in the case of UCO Bank, when top management posts have remained vacant for considerable lengths of time. In the case of Indian Bank, repeated extensions of tenure of three months each were given to the CMD. Short tenures and frequent changes lead to the adoption by the management of a tentative approach towards serious issues and lack of long term strategic planning. Inadequate support from the Board of Directors 4.29 Guidance and support received by the three banks from their respective Board of Directors has been less than adequate. These Boards are not broad-based enough to include sufficient number of experts from areas related to banking, finance and management and have not always been able to provide the kind of support and guidance that is needed in a critical situation. Lackadaisical implementation of earlier SRPs and MOUs 4.30 Restructuring efforts made so far have mostly been in the form of recapitalisation and have practically been unconditional. Though Strategic Revival Plans (SRP) were prepared and Memoranda of Understanding (MOU) with performance targets signed, measures to be taken in the event of the concerned banks failure to fulfil the understanding or to meet the performance targets agreed upon were not thought of. The SRPs and MoUs, therefore, were never more than guidelines. The result is that, even after the infusion of Rs. 6,740 crore in the three banks over the last seven years, their basic weaknesses still persist. Unfailing and unconditional recapitalisation 4.31 Management, the work force, as well as the unions have, therefore, tended to take things easy and no serious effort has been made to address the problem in the firm belief that government support will be forthcoming whenever needed. Unfailing and unconditional financial support by way of recapitalisation from the Government of India has actually proved to be a moral hazard.

Chapter 5 Past efforts at restructuring 5.1 As stipulated by the Reserve Bank of India, banks were required to attain capital adequacy ratio of 8 per cent by 31 March 1996. Since quite a few public sector banks were not fulfilling this requirement, Government of India had to infuse fresh capital in all the 19 nationalised banks. Under this programme, the government infused as capital Rs. 6,400 crore in 1993-94 and a further Rs. 4,362 crore in 199495. The capital infusion was through issuance of bonds carrying fixed coupon rates initially at the rate of 7.75 per cent per annum which, in subsequent issues, was raised to 10 per cent. Besides this, under the project sponsored by the World Bank for capital restructuring, the government availed of US$ 150 million as retroactive finance and provided these funds to six public sector banks by way of subordinated debt for their modernisation initiatives. In all, the Government of India has so far spent Rs. 20,446 crore on recapitalisation of the nationalised banks. 5.2 In order to prescribe some conditionalities for the assistance extended, the government desired that RBI may finalise a set of performance obligations and commitments in consultation with the CMDs of the banks to be fulfilled by them. The first such exercise was undertaken in 1992-93. Targets of performance were set for being achieved by the banks receiving assistance during the year. These targets/undertakings were contained in Memoranda of Understanding (MOU) entered into by the banks with RBI. The banks performance, vis--vis targets, was reviewed at the end of the year to assess performance and to identify the reasons for shortfall, if any. The exercise initially covered all the nationalised banks which received capital infusion. Subsequently, as the performance of some of these banks improved substantially and the governments share in their equity started coming down due to public issues of equity made, a few banks were taken out of the purview of the MOU arrangement. 5.3 In the year 1997-98, the government decided to grant autonomy in respect of a few staff-related issues and branch expansion to those banks which had attained certain benchmark levels. These were capital adequacy of more than 8 per cent, minimum owned funds of Rs. 100 crore, uninterrupted record of profit for the immediately preceding three years and net NPA levels below 9 per cent. The banks eligible for autonomy were also excluded from the MOU exercise, which is presently confined only to seven banks. Indian Bank, UCO Bank and United Bank of India are additionally covered by bank-specific Strategic Revival Plans (SRP). 5.4 The Working Group observed that the MOU exercise had only a limited success in improving the financials of the weak banks. Linked with capital infusion by the government, the MOU exercise was aimed at rectifying the shortcomings of concerned banks so that they could reduce their losses and improve profitability. It has also been observed that in order to improve the conditions at these banks at a faster pace they were mostly given performance targets which were quite high and by their standards rather stretched. In most cases, therefore, these targets were not met. While less arduous obligations relating to deposit mobilisation, housekeeping,

improving investment yield, etc., were often fulfilled, in more critical areas of performance such as expansion and diversification of credit, reduction of NPAs, prevention of slippage in NPAs, improvement in net interest margins, and reduction of costs, etc., the success achieved by the banks was very limited. Although such failures to achieve agreed targets or to fulfil commitments were frequent, there never were any penalties for such failures. Banks reporting operating losses were, no doubt, barred from opening new branches, recruitment of staff and fresh capital expenditure without RBI approval, but these restrictions did not serve as a disciplining measure as, in any case, they were already overstaffed and were in no position to undertake branch expansion or to incur any major capital expenditure. 5.5 The Group also observed that one of the reasons for the MOU exercise not succeeding was the manner in which it was conducted. The exercise for a particular bank normally began some time in June/July after the audited balance sheets were available. It took till about October/November to arrive at the understanding with the result that the remaining five months of the year were hardly sufficient to reach the agreed targets/commitments. In the short period left to them in the financial year for which the targets were agreed, the banks had hardly any time to develop an effective plan and to put them in action. In fact, the banks hardly if ever showed any strong commitment to the MOU with the result that it could never serve the purpose for which it was conceived, namely, removing the basic weakness of these banks. The government, however, continued to provide them with the required capital to meet the needs for their capital adequacy notwithstanding the continuous failures of these banks to meet their commitments in regard to their performance. 5.6 After the initial round of MOU exercise, four out of the eight nationalised banks which incurred operating losses in 1992-93 (viz., UCO Bank, United Bank of India, Bank of Maharashtra and Central Bank of India) were identified for specific restructuring efforts. In September 1994, RBI in consultation with the Government of India appointed consultants for the banks as indicated below: 1. Bank of Maharashtra Shri W.S. Tambe, former ED, RBI, in consultation with NIBM 2. Central Bank of India KPMG Peat Marwick 3. UCO Bank ICRA Ltd. 4. United Bank of India ICRA Ltd. Indian Bank was added to the list after it incurred huge losses in 1995-96 and ICRA was appointed in 1996 as consultants with RBI concurrence, for conducting a diagnostic study of the bank and suggesting measures for its revival. Restructuring efforts 5.7 The consultants were mandated, inter alia, to formulate strategies for the five banks mainly in respect of the following: a. b. Reduction of non-performing assets. Increasing income and reduction of costs.

c. d. e. f.

Rationalisation of staffing pattern and branch structure. Exploration of the possibility of a limited asset reconstruction fund. Product analysis and product delivery. Information system and business projections.

5.8 The consultants studied the working of the banks and some of the major deficiencies in the banks as observed by them were as under: a. Comparatively lower resource base and lower volume of business (fund and non-fund based) resulting in lower income generation. b. High proportion of NPAs and high rate of NPA generation. c. Increasing administrative expenses not commensurate with the level of business and income. d. Overstaffing (estimated at around 20 per cent in UCO Bank and UBI). e. Absence of strategic planning, MIS, risk management and internal controls. f . Unremunerative operations of overseas branches and subsidiaries. 5.9 Based on the diagnostic studies, the following measures towards restructuring the banks were recommended by the consultants: a. Massive capital infusion (UCO Bank Rs. 375 crore, United Bank of India Rs. 550 crore, Indian Bank Rs. 2,150 crore, Bank of Maharashtra Rs.150 crore). b. Total management of NPAs through (i) Setting up of ARF for taking over NPA accounts aggregating Rs. 808 crore, Rs. 281 crore and Rs. 313 crore from Indian Bank, UCO Bank and United Bank of India respectively, and (ii) Recovery of NPAs through judiciously negotiated compromise, settlement and invocation of government guarantees. c. Cost reduction through wage freeze and downsizing through VRS (UCO Bank, United Bank of India and Central Bank of India). d. Improving the business through deposit growth to bring it on par with that of leading banks and better credit delivery through revamping of credit appraisal systems. e. The consultants also recommended splitting the CMDs post into that of a nonexecutive Chairman and a Managing Director, addressing the problem of inadequate senior management due to serious gaps in succession (in UCO

Bank and UBI), cost reduction and business improvement through winding up of overseas operation of UCO Bank and Indian Bank, improved customer service, housekeeping, rationalisation of branches, redeployment of excess manpower in deficit areas, recruiting professionals in merchant banking, MIS and strategic planning, etc., and setting up of Asset Liability Management Committee (ALCO) (Indian Bank). 5.10 Based on the recommendations of the consultants, the banks initiated measures for improving deposit mobilisation, recovery of NPAs, toning up of credit management system, improving housekeeping, etc. However, there were reservations on the strategy suggested on wage freeze, VRS and closure of overseas branches. Setting up of an ARF was not found to be feasible by the GOI/RBI. 5.11 Consequent to the attempts made from within, two out of the five banks, Bank of Maharashtra and Central Bank of India, improved their levels of performance. During 1995-96, Bank of Maharashtra posted a net profit of Rs.12.60 crore helped by an increase in its interest spread to working funds from 2.92 per cent to 3.83 per cent and a growth rate of 28 per cent in other income. The banks gross NPAs declined from 25.7 per cent of gross advances to 21.9 per cent during the period. The bank continued to show profits thereafter. Central Bank of India came out of the red in 1996-97 with a net profit of Rs. 150.83 crore. The banks interest spread to working funds increased from 2.65 per cent in 1994-95 to 3.21 per cent in 1996-97. In view of the above, it was decided to confine the exercise of monitoring the progress under revival strategies only to the other three banks, viz., Indian Bank, UCO Bank and United Bank of India. Strategic Revival Plan 5.12 At the instance of the then Finance Minister, these banks drew up Strategic Revival Plans (SRPs) for their turnaround. The restructuring plans drawn to remove the weaknesses identified by the consultants aimed at achieving profitability targets in definitive timeframes through improvement in key performance areas such as mobilisation of low cost deposits, reduction of high cost CDs, improving credit management system to ensure containment of NPA generation and recovery of NPAs, improving housekeeping and toning up of MIS, etc. The staff unions of the weak banks also signed an MOU assuring higher productivity and removal of restrictive practices. Indian Bank and UCO Bank also constituted Committees of Directors to monitor the progress made under their SRPs. Implementation of SRPs 5.13 The banks did adopt the revival plans but the extent of success achieved thereunder is far from significant. Certain measures such as setting up of ALCO at Head Office, Settlement Advisory Committees and recovery cells for recovery of NPAs were implemented. However, the banks were unable to achieve the important objectives of earning profit and reducing losses by 1998-99. All the banks reported operating losses in 1996-97 and barring UBI which could manage net profit during

1997-98 (due to receipt of an unusual income of Rs. 111 crore by way of interest on Income Tax refund), the other two reported losses. Indian Bank continued to incur operating loss in 1998-99 as well. Despite their dismal record, the Government of India infused capital of Rs. 2,100 crore in 1997-98 and Rs. 400 crore in 1998-99 in these banks to shore up their CAR. 5.14 As briefly stated above, performance of the three banks under the SRPs was not satisfactory. The banks were aware that non-fulfilment of the obligations would not lead to any adverse impact on their overall continuance. The MOUs with the Unions also had only a limited impact on cost reduction as the sacrifices made were only peripheral such as reduction in overtime and certain other allowances. The other measures of cost control such as rationalisation of a few existing branches, embargo on new branches, curtailment of major capital expenditure, etc., did not have any major impact and the cost income ratio of UCO Bank and United Bank of India continued to exceed 90 per cent, and that of Indian Bank 140 per cent, even by March 1999. The only significant result has been the closure by UCO Bank of its London branch and merger of its two branches in Singapore. 5.15 In a belated recognition of the need for action, the committee of the Board of UCO Bank set up to monitor progress under revival plan had recommended (i) downsizing of the staff strength through VRS (7,000 staff to be reduced in a phased manner in three years), (ii) further capital infusion of Rs. 250 crore by the government, (iii) mobilisation of Tier II capital, (iv) Non-implementation of wage settlement, and (v) closure/merger of loss making branches. The recommendations have not been supported by the representatives of the staff. There have been no serious follow-up measures to implement the recommendations. 5.16 To sum up, the restructuring efforts initiated so far have not had the desired impact. The hard options have been avoided and the steps taken so far have had the clear objective of maintaining the capital adequacy ratio of the banks with the assistance of Government of India so as to remain afloat. The banks have failed to develop the required resilience or strength to become competitive in the true sense. The past restructuring attempts were thus feeble and could be deemed as holding on operations without the perspective of improving the banks long term viability and competitive efficiency.

Chapter 6 Present position of the weak banks 6.1 The Working Group has examined the financial position of the three weak banks based on their results till the year ended March 1999. An analysis of the current position of the banks based on the published results of Indian Bank, UCO Bank and United Bank of India for the year ended 31 March 1999 is given below. Indian Bank 6.2 The financial position of the bank has steadily deteriorated over the last three years. A summary of the Income and Expenditure Account of the bank and a few important financial indicators for the last three years are furnished below: Table 5: Indian Bank Financial indicators (Amount in Rs. crore) 1996-97 Interest Income Other Income Total Income Interest Expense Operating Expenses Total Expenses Operating profit/loss Provisions and Contingencies Net Profit/Loss Interest on Recap bonds Net Interest Margin (%) Gross NPAs Percentage to gross advances Net NPAs Percentage to net advances Capital Adequacy Ratio (%) 1,563 217 1,780 1,442 477 1,919 (-) 139 250 (-) 389 38 0.81 3,303 39 1,735 25 (-) 18.81 1997-98 1,464 202 1,666 1,353 523 1,876 (-) 210 92 (-) 302 38 0.65 3,428 39 1,889 26 1.41 1998-99 1,625 199 1,824 1,428 559 1,987 (-) 163 615 (-) 778 235 1.08 3,709 37 1,644 21 (-) 8.94

6.3 The bank continued to incur operating losses in 1998-99 also. The operating loss in 1998-99 was lower as compared to 1997-98, due to accretion of additional interest income (Rs. 175 crore) on the recapitalisation of Rs. 1,750 crore received in 1998. The operating loss of the bank adjusted for the income on recapitalisation bonds has increased steadily and aggregated Rs. 177 crore, Rs. 248 crore and Rs. 398 crore during 1996-97, 1997-98 and 1998-99 respectively. The capital adequacy turned positive with the infusion of Rs. 1,750 crore and reached 1.41 per cent in March 1998. It turned negative again in March 1999. Despite recapitalisation of the bank by the Government of India to the extent of Rs. 100 crore in 1998-99, it has ended up with a negative net worth. 6.4 The total income of the bank during 1998-99 grew only by Rs. 158 crore (9.5 per cent). The share of interest income in the total income during 1998-99 was 89.1 per cent, marginally higher than 87.9 per cent recorded in 1997-98. The decline in other income continued during 1998-99 as well and was at Rs. 199 crore (i.e., 10.9 per cent of

the total income) as against Rs. 217 crore and Rs. 202 crore recorded in 1997 and 1998 respectively. The bank did not make any provision for liabilities arising on account of the proposed wage revision. 6.5 The total expenses in 1998-99 was higher than that of 1997-98 by Rs. 111 crore (5.9 per cent) though it had gone down between 1996-97 and 1997-98. The share of interest expenses and other expenditure during 1998-99 had remained nearly at the same level as the previous year, viz., 72 per cent and 28 per cent. The deterioration on the NPA front is unabated. Gross NPAs went up to Rs. 3,709 crore as on 31 March 1999 from Rs. 3,428 crore as on 31 March 1998. In percentage terms, the gross NPAs constituted 37 per cent of gross advances, the highest among public sector banks. The net NPAs stood at Rs. 1,644 crore as on 31 March 1999 as against Rs. 1,889 crore as on 31 March 1998. Reduction in the amount of net NPAs in this case is not an indication of improvement as the additional provisions, which have brought it down, did not come out of operating income. These have only added to the net losses. UCO Bank 9.6 A summary of the Income and Expenditure Account of the bank and a few important financial indicators for the last three years are furnished in the table below. As may be seen from the table, the banks operating profit improved marginally in 1998-99 as compared to 1997-98. However, if the interest income on recapitalisation bonds is excluded, the bank would have incurred operating loss of Rs. 91 crore in 1997-98 and Rs. 157 crore in 1998-99. The recapitalisation of the bank by the Government of India to the tune of Rs. 200 crore helped the bank to maintain capital adequacy of 9.63 per cent in 1998-99 also.

Table 6: UCO Bank Financial indicators (Rs. In crore) 1996-97 Interest Income Other Income Total Income Interest Expense Operating Expenses Total Expenses Operating profit/loss Provisions and Contingencies Net Profit/Loss Net Interest Margin (%) Interest on recap bonds Gross NPAs Percentage to Gross advances Net NPAs Percentage to net advances Capital Adequacy Ratio (%) 1,303 127 1,430 987 516 1,503 (-) 73 103 (-) 176 1.99 101 1,873 28 753 14 3.16 1997-98 1,445 192 1,637 1,085 537 1,622 15 111 (-) 96 2.14 106 1,780 24 705 11 9.07 1998-99 1,693 187 1,880 1,247 595 1,842 38 106 (-) 68 2.36 195 1,716 23 716 11 9.63

6.7 Total income during 1998-99 registered an increase of Rs. 243 crore (17.2 per cent) over that of 1997-98. The interest income as a percentage of total income increased from 88.3 per

cent in 1997-98 to 90.1 percent in 1998-99. However, the share of other income in total income decreased from 11.7 per cent in 1997-98 to 9.9 per cent in 1998-99. On the expenditure side, the share of interest and operating expenses in the total expenditure did not vary very significantly over the two years. The bank has not made provision for liability on account of wage revision. 6.8 The banks gross NPAs as on 31 March 1999 aggregated Rs. 1,716 crore (23 per cent of gross advances) as against Rs. 1,780 crore (24 per cent of gross advances) as on 31 March 1998 showing marginal decline both in absolute and percentage terms. However, the net NPAs at Rs. 715.63 crore were higher as compared to Rs. 705 crore as on 31 March 1998. It would appear that while the bank has written off NPAs which were already fully provided for, the net NPAs have grown due to fresh additions. The inability of the bank to register any improvement in net NPA position is a matter for concern. It is likely that the provisioning requirements have been comparatively lesser during 1998-99. United Bank of India 6.9 A summary of the Income and Expenditure Account of the bank and a few important financial indicators for the last three years is as under. Table 7: United Bank of India Financial indicators (Rs. in crore) 1996-97 1997-98 1998-99

Interest Income @ 1,007 1,334 1,453 Other Income 97 141 114 Total Income 1,104 1,475 1,567 Interest Expense 800 936 1,108 Operating Expenses 359 375 413 Total Expenses 1,159 1,311 1,521 Operating profit/loss (-) 55 164 46 Provisions and Contingencies 59 155 31 Net Profit/Loss (-) 114 9 15 Net Interest Margin (%) 1.73 2.22 1.95 Interest on recap bonds 118 142 163 Gross NPAs 1,398 1,451 1,549 Percentage to Gross advances 36 34 32 Net NPAs 567 472 573 Percentage to net advances 19 14 15 Capital Adequacy Ratio (%) 8.23 8.41 9.60 @: includes extraordinary income of Rs. 111 crore in 1997-98 and Rs. 36 crore in 1998-99 respectively on account of interest on IT refund. 6.10 As seen from the above, the banks operating profit decreased substantially in 1998-99 as compared to 1997-98. During both the years, the operating profit increased mainly on account of extraordinary income as indicated above. Further, if the interest income on recapitalisation bonds is excluded, the bank would have incurred operating loss of Rs. 89 crore in 1997-98 and Rs. 117 crore in 1998-99. The recapitalisation of the bank by the Government of India to the tune of Rs. 100 crore helped the bank to maintain capital adequacy of 9.6 per cent in 1998-99.

6.11 Total income during 1998-99 registered an increase of only Rs. 92 crore over that of 1997-98. The interest income as a percentage of total income increased from 90.4 per cent in 1997-98 to 92.7 per cent in 1998-99. However, the share of other income in total income decreased from 9.6 per cent in 1997-98 to 7.3 per cent in 199899. On the expenditure side, the total expenditure rose by Rs. 210 crore. The share of interest expenditure in total expenditure has been going up over the last three years, i.e., from 69 per cent in 1996-97 to 71.4 per cent in 1997-98 and 72.8 per cent in 1998-99 indicating higher cost of funds. The bank has not made provision during 1998-99 for future pension liability and wage revision. 6.12 The gross NPAs of the bank as on 31 March 1999 increased to Rs. 1,549 crore from Rs. 1,451 crore as on 31 March 1998. The net NPAs also went up to Rs. 573 crore as on 31 March 1999 from Rs. 472 crore as on 31 March 1998. The percentage of gross NPAs however marginally declined to 32 per cent from 34 per cent while net NPAs increased to 15 per cent from 14 per cent. Analysis of projected business plans 6.13 During the course of preliminary discussions, the Working Group requested the CMDs of the three weak banks to pinpoint the underlying causes of their weaknesses and why they had not been able to achieve a viable turnaround despite various rounds of MOU and Strategic Revival Plan exercises. The Working Group also advised the CMDs of banks to take note of the past deficiencies in the formulation and implementation of the plans and draw up afresh what in their view constituted, viable business revival plans on a realistic basis. The banks were advised to demarcate milestones which could be monitored in their progress towards revival and also to assess the capital support that they would be requiring from the Government of India for completing the restructuring exercise. The three sub-groups constituted to study in detail the three weak banks, before drawing any conclusion of their own, critically analysed whether these business plans drawn up by the banks were feasible and could enable the banks to achieve a turnaround on sustained basis. The reports and assessments of the three sub-groups on this exercise are detailed in the following paragraphs. Restructuring Plan of Indian Bank 6.14 The bank provided the sub-group during May 1999 their projected action plan for achieving sustained profitability over the next five years. The projections in respect of the important parameters are listed in Table 8. It may be added that the projected figures of performance for 1998-99 given by the bank earlier is at variance with the actual figures reported subsequently in July 1999. However, the analysis is based on the initial estimates/projections provided to the sub-group. 6.15 The banks projected restructuring plan was also confined only to its domestic operations and was extended up to the year ending March 2002 when it expected to make an operating profit of Rs. 29 crore. The bank was not in a position to assess its provisioning requirements for the period and was therefore unable to arrive at the estimated net profit figures. The bank was also not able to indicate the recapitalisation requirements during the restructuring process nor could it furnish the projected improvements in Net Interest Margin or Return on Assets. The sub-group was informed that the projections were based mainly on expected levels of growth in business and increase in incomes. On the expenditure front, annual increase in staff cost was taken uniformly at 10 per cent without building in the proposed wage revision.

The other assumptions of the bank while drawing up the projected business plan are as under: a. Regulatory forbearance (including CRR at the minimum level of 3 per cent). Favoured treatment for PSU accounts, higher food credit allocation, and higher share in consortium accounts. Retailing of government securities. NPA reduction through aggressive recoveries at various levels.

b.

c. d.

Table 8: Indian Bank Banks projections (Rs.in crore) March 1999 14,777 11.5 7,193 2.3 7,174 32.95 1,489 180 1,669 1,322 619 1,941 (-) 272 14.3 10.65 3,646 179 155 3,670 March 2000 16,819 13.8 8,090 12.5 8,054 12.27 1,704 171 1,875 1,431 656 2,087 (-) 212 14.5 10.66 3,670 125 300 3,495 March 2001 19,315 14.8 9,310 15.1 9,069 12.60 2,016 188 2,204 1,598 721 2,319 (-) 115 14.5 10.67 3,495 120 300 3,315 March 2002 22,213 15.0 11,086 19.1 9,886 9.00 2,393 207 2,600 1,778 793 2,571 29 14.5 10.66 3,315 120 300 3,135

Deposits Growth (%) Advances Growth (%) Investments Growth (%) Interest Income Other Income Total Income Interest Expenditure Other Expenditure Total Expenditure Operating profit Yield on advances (%) Yield on Investments (%) Gross NPAs at the beginning of the year Addition of NPAs Reduction of NPAs Gross NPAs at the end of the year Analysis of the projected business plan

6.16 The sub-group noted that the business plans were deficient and failed to provide any realistic basis for a meaningful analysis of the likely growth in its income or profits. The plans which were devoid of critical data on the possible levels of CAR in the ensuing years, the quantum of expected capital shortfalls and the overall requirements of provisions, made the task of assessment of the viability plan difficult. The managements perception that the bank will not be able to earn net profit in its operations till the end of the year 2001-02 is a sad commentary on its current state of affairs. Even on the banks own assumptions the expected operating profit at the end of the year 2001-02 is likely to be a meagre Rs. 28.69 crore. Clearly, this level of income generation would be totally inadequate to support provisioning requirements necessary to earn net profit. The obvious inference was that for the bank, the stage of recording net

profits was much farther beyond 2001-02. The turnaround of the bank, measured in terms of its ability to earn net profit, is therefore unlikely in the foreseeable future unless drastic cost cutting measures are resorted to. 6.17 The sub-group also assessed the feasibility of the bank achieving the other projected growth levels and observed that many of them were not realistic in the light of the banks growth pattern in the last few years and lack of intrinsic strength to grow at a rapid pace, especially in a very competitive external environment. The projected yield on advances and diversification of the portfolio are unlikely to materialise since even the existing limits sanctioned to corporate bodies are not being availed of by them fully due to the banks higher rates of interest. The yield on investment is, however, feasible. With no major improvements expected in its financials, the cost of funds is not expected to decline as projected and may in fact even go up from the current levels. Non-interest income, which is largely linked to growth in credit portfolio, may not increase as planned. 6.18 On the expenditure side, the bank has not taken into account the impact of the proposed wage revision. The proposal to limit annual growth of staff expenses to a uniform level of 10 per cent is out of alignment with the growth under this head at the rate of 16 per cent for the last ten years. Above all, the key factor in the turnaround of Indian Bank is critically linked to the management of its NPAs at Rs. 3,709 crore which is the highest among public sector banks in percentage terms (i.e., 37 per cent of gross advances). The banks projections for slippages in NPAs estimated at respectively 2.2 per cent, 1.6 per cent and 1.25 per cent in the next three years are clearly unrealistic with the bank reporting slippage ratio of 21 per cent in 1996, 10.7 per cent in 1997 and 9.2 per cent in 1998. It may be added that even the low slippage of 1998 is above the median level of slippage in NPAs of public sector banks for the year 1998 at 6.2 per cent. The assumption that NPAs would go down sharply as a result of aggressive recovery appears to be misplaced, particularly because a number of high value borrowal accounts are under investigation/ scrutiny and compromise proposals, despite the setting up of a high level Settlement Advisory Committee, are not making much headway. The sub-group was also concerned to note emerging signs of slippage in the existing portfolio of performing advances. In sum, the business plan submitted by the bank is far removed from reality and its pursuance can only prolong the cost and time of the restructuring. The enormous burden of NPAs is a big stumbling block in the banks turnaround efforts. 6.19 The sub-group, therefore, worked on modified business plans built around more realistic scenarios and taking into account the banks capabilities. The scenarios were built on realistic assumptions of business growth, containment of staff expenses at different levels and also the cleaning up of the balance sheet through transfer of NPAs to an Asset Reconstruction Company. A summary of the various scenarios is contained in the Executive Summary of the sub-group report provided at Annex 4. The conclusion that emerges from the analysis is that the bank would not be able to make a turnaround until 2004 unless there is drastic reduction in staff and other expenses and the banks NPA problem is met by transferring these to a specialised debt recovery/asset reconstruction agency. The sub-group also observed that alternative scenarios envisaging capital infusion not accompanied by reduction in expenditure would not assist the banks turnaround and, therefore, prove infructuous. The sub-groups scrutiny has revealed that in only one of the alternatives suggested by the bank is turnaround feasible. This particular scenario factors in expenditure containment, transfer of the banks NPA to an asset reconstruction agency and capital infusion of around Rs. 2,000 crore between 1999

and 2003. Restructuring Plan of UCO Bank 6.20 The banks projections in respect of certain important parameters are given in Table 9. Table 9: UCO Bank Banks projections (Amount in Rs. crore) March March March March March March 1999 2000 2001 2002 2003 2004 Deposits 16,710 19,115 21,890 25,035 28,665 32,590 Growth (%) 16 14 15 14 14 14 Advances 5,667 6,922 8,437 10,262 12,652 15,642 Growth (%) 1 22 22 22 23 24 Investments 6,532 7,525 8,450 9,345 10,205 11,074 Growth (%) (-)12.95 15.20 12.29 10.59 9.20 8.51 Interest Income 1,668 1,865 2,148 2,455 2,798 3,207 Other Income 169 201 239 284 339 403 Total Income 1,837 2,066 2,387 2,739 3,137 3,610 Interest Expenditure 1,218 1,349 1,519 1,741 1,995 2,287 Other Expenditure 589 684 729 786 857 927 Total Expenditure 1,807 2,033 2,248 2,527 2,852 3,214 Operating profits 30 33 139 212 285 396 Provisions and Contingencies 184 115 120 131 135 140 Net profit (-)154 (-) 82 19 81 150 256 Note: The projections for 1999 furnished in May 1999 to the sub-group vary from the actual data published in June 1999 and indicated earlier in this chapter. Non-Performing advances 6.21 The banks gross NPAs as on 31 March 1999 aggregated Rs. 1,716 crore (23 per cent of gross advances) and performing advances stood at Rs. 5,893 crore. The bank has not provided detailed annual projections indicating the expected recovery/reduction of NPAs or the likely incidence of fresh NPAs during the five-year period. Instead, the bank has assumed slippage of three per cent every year on the level of performing advances uniformly and reduction of NPAs in stages from the current level of 22 per cent to a level of 5 per cent by the year 2004. The bank has projected a yield between 8 8.5 per cent on advances and a return on investment between 13 15 per cent in the business plans without indicating the specific target year-wise. Analysis of the projected business plan 6.22 The bank has drawn up the proposed plan taking into account its past experience in the implementation of the strategic revival plans. The assumptions of structural and systemic steps contemplated by the bank to achieve the projections relate broadly to: a. Clear business focus on mid market segments and introduction of new retail products. b. Improving recoveries through camps and compromise settlements.

c. Revamping the organisational structure combined with rationalisation of branches and reducing levels of decision making. d. Capital infusion aggregating Rs. 2,814 crore to maintain minimum CAR of 9 per cent in 2000 and 10 per cent thereafter. 6.23 The sub-group has noted that the projected business plan envisaged net profit of Rs. 19 crore to be generated in the year 2000-01 which is expected to grow in the subsequent years. The bank is not likely to record current median levels of minimum competitive efficiency even by 2003. It is pertinent to remember that by then, the efficiency parameters of the remaining public sector banks would have moved up considerably. 6.24 The sub-group assessed the revised business plan targets with reference to the capability of the bank based on its past record and the industry scenario. The growth projected in deposits appears reasonable while that in credit is clearly optimistic. Consequently, the assumptions behind the higher net interest income as well as growth in non-interest income of about 19 per cent (as against industry average of 12.7 per cent) are not realistic. The bank is also unlikely to reach projected levels of yield on investments with the planned shift to credit portfolio and the future movements in interest rates. Likewise, the reduction of NPAs to 5 per cent by year 2004 is out of line with the current levels of recovery performance. The assumptions behind the banks business plans do not appear feasible and the sub-group has, therefore, drawn up modified plans. These have been built upon three different scenarios based on different growth levels in business, viz., advances, deposits, return on investments, non-interest income and expected level of NPAs. The scenarios also envisage reduction in the staff cost to the industry level in phases or in a single year. The sub-group concluded that in all scenarios, it would require a minimum of four years to reach a reasonable level of net profit. An earlier turnaround is, however, feasible if reduction of staff cost to industry median is attempted through wage reduction and postponing the industry wide wage revision as detailed in the scenario. The estimate of the additional capital infusion requirement from the government would vary between Rs. 600 and Rs. 1,800 crore under the three different scenarios. Restructuring Plan of United Bank of India 6.25 The banks projections in respect of important parameters contained in its action plan for achieving sustained profitability over the next five years are given below. Table 10: United Bank of India - Banks projections (Amount in Rs. crore) March March 1999 2000 14,513 16,646 18.3 16 3,742 4,562 12.7 15 7,182 8,583 31.32 19.50 1,421 1,640 95 145 March 2001 19,288 16 5,469 15 10,146 18.23 1,913 174 March 2002 22,364 16 6,470 15 11,972 17.99 2,226 209 March March 2003 2004 25,934 30,072 16 16 7,583 8,847 15 15 14,202 16,847 18.63 18.62 2,616 3,031 251 301

Deposits Growth (%) Advances Growth (%) Investments Growth (%) Interest Income Other Income

Total Income 1,516 1,785 2,087 2,435 2,867 3,332 Interest Expenditure 1,098 1,257 1,434 1,640 1,902 2,178 Other Expenditure 407 503 564 633 708 791 Total Expenditure 1,505 1,760 1,998 2,273 2,610 2,969 Operating profit 11 25 89 162 257 363 Provisions and Contingencies 8 10 28 49 77 91 Net profit 3 15 61 113 180 272 Yield on advances (%) 14.5 14.0 13.8 13.8 13.6 13.4 Yield on investments (%) 11.8 11.3 11.2 11.1 11.1 11.0 Gross NPA at beginning of year 1,451 1,446 1,362 1,237 1,137 1,062 Expected Addition 150 100 95 120 125 150 Expected Reduction 155 184 220 220 200 230 Gross NPA at year-end 1,446 1,362 1,237 1,137 1,062 982 Note: The projections for 1999 furnished in May 1999 to sub-group vary from the actual data published in June 1999 and indicated earlier in this chapter. 6.26 The key assumptions behind the projections are: a. The expenses towards staff would not increase on account of the proposed wage revision and arrears also would not be payable. (However, the bank has also worked out three scenarios of staff expenses contemplating (i) without wage revision, (ii) with wage revision but without payment of arrears, and (iii) with wage revision and payment of arrears). b. Capital adequacy would remain at 9 per cent till 2002 (provided wage levels do not increase and thereby erode its profitability). Requirement, that would arise, can be met through Tier II bonds to the permitted extent. c. The income growth would be based on changing the business focus by expanding into new areas of credit, acquiring accounts of large PSUs with government assistance and reduction of NPAs through aggressive recoveries and transfer of NPAs over Rs. 10 lakh to ARC. d. Improvement in non-fund income through various products. Analysis of the projected business plan 6.27 The projected business plan and the underlying assumptions were examined by the subgroup in the light of historic rates of growth of business, compounded annual growth rate, external competition, vulnerability of the existing advances and investment portfolio over the next five years and a conservative level of slippage in NPAs. The projections of growth in credit and non-interest income are unlikely to be achieved given the current levels of skill and technology in the bank. The projected decline in yields on investments as well as on advances is understandable but more important is the issue of their success in acquiring appropriate assets for investment in the teeth of competition. The projections in respect of reduction in NPAs and slippages as well as the resultant reduction in the burden of provisioning requirements were, in the opinion of the sub-group, not in line with the experience of the bank. The sub-group therefore observed that the bank would not be in a position to attain the profitability levels projected as above. The bank would continue to incur losses over the next five years, may be, at a declining rate. If the wage revisions become applicable, even as per

the banks own estimates, capital adequacy would go below the prescribed level. The subgroup also estimated that if wage revision is made applicable, the banks CAR could fall below 4 per cent by 2002 as against 6.9 per cent estimated by the bank. Based on the above assumption, the estimated capital infusion required would be in the range of Rs. 565 crore over the next five years. The sub-group has, therefore, concluded that the projected plan of revival is not realistic and that the bank is not likely to be able to turn around within the next five years unless drastic cost reduction is undertaken on an urgent basis. For its revival and even continuation as at present, further sizeable capital infusion by the government is unavoidable. Conclusion 6.28 As discussed in detail in Chapter 5, the three weak banks were unable to achieve a turnaround as contemplated under the revival plans. This was possibly because the plans drawn up in the course of strategic revival exercises with the help of consultants or at the time of discussions with the Reserve Bank of India during the MOU exercises took a very optimistic view of the banks capability to implement the plan successfully. Recognising the fact that a revival plan with the best chances of success could possibly be drawn up by the banks themselves, the Group considered it necessary to advise them to draw up realistic restructuring plans consistent with their inherent capabilities. The Group also made it clear that plans, which do not address the main causes of declining income and increasing costs, would not help revival. Moreover, the challenges of emerging competition and continuing deregulation are bound to have an impact on any business restructuring plan extending over four to five years. The banks were, therefore, advised that they should, while drawing up the plans, consider carefully the organisations inherent strengths and weaknesses, the likely direction that the industry and their own business will take in future, their requirement of capital (Tier I as well as Tier II), its sources and all measures needed to be taken towards a comprehensive financial and operational restructuring for their revival. It also needs to be appreciated that the prospects of receiving large capital infusions from the government would recede year after year. The banks must, therefore, plan to improve their overall efficiency and compete successfully rather than plan to remain afloat only with the help of capital infusions by the government. 6.29 The Group is constrained to observe that the plans prepared by the banks at its instance were no better than the earlier ones that failed. The study of these banks has highlighted a number of organisational and personnel-related weaknesses that would hinder achievement of their own growth projections. The plans continue to be based on ambitious projections of growth in business and income for which the banks do not seem to be equipped either in terms of skill or technology. The plans do not also reflect the growing compulsions of achieving steady growth in income and sustained control of expenditure within as short a time as possible. The Working Group, therefore, had to conclude that the restructuring plans drawn up by the banks do not meet the objectives. The impression gathered is that, as long as these banks are assured of continued capital infusion by the Government of India, they would look only at soft options regardless of the time and cost of restructuring. 6.30 In view of the foregoing, an objective and comprehensive approach to restructuring of these banks is necessary. The Working Groups recommendations regarding a viable and comprehensive restructuring strategy and other accompanying measures that are necessary for its implementation are discussed in Chapter 7.

Chapter 7 Restructuring strategy 7.1 Much of the discussion that will follow in this chapter will have emerged from the past international experiences as well as our own in restructuring weak banks, some of which have been recorded in Chapters 2 and 5 of this report. There are indeed no accepted best practices in this regard. However, there are some basics which apply everywhere and if not heeded will nullify any attempt at restructuring howsoever sincere and expensive it may be. 7.2 The first most important principle is that the restructuring exercise has to be comprehensive. It must address operational and financial restructuring simultaneously. In bank restructuring there is never any room for half way measures or gradualism. Any such exercise which does not encompass both operational and financial restructuring has in it seeds of failure and invariably fails. Our own experience in this regard so far has not been any different. It is very tempting to confine restructuring to financial aspects since solvency is immediately restored and there is a visible impact on the balance sheet. This no doubt appears to be the easiest, but hardly, if ever, would it lead to lasting removal of the ingrained weakness. If operational aspects crying for correction are not attended to long term sustainability of the bank cannot be ensured. This will only lead to additional problems necessitating further and costlier restructuring down the road. 7.3 There is always a tendency on the part of weak banks to overlook or hide their weaknesses. A hope that the position will be corrected soon is eternal and such thinking, self defeating as it is, almost invariably delays the really needed corrective action. In the meantime, the banks themselves, opting for incorrect and often riskier business strategies, try to show better short term results. In the process the cost of restructuring goes up and if delayed too much the possibility itself, of a successful restructuring, becomes remote. Unfortunately, our approach to bank restructuring so far has been somewhat akin to what has been described above and it is time that a far more comprehensive and decisive view of the issue is taken. 7.4 Future restructuring strategies for weak banks must incorporate the following core principles: a. Manageable cost: The restructuring effort that is embarked upon has to be at the least cost possible. However, the fact that injudiciously chosen lower cost alternatives may lead to much higher costs in the long term must not be lost sight of. b. Least possible burden on the public exchequer: As far as practicable the cost of restructuring must come out of the unit being restructured. Even if its contribution to the cost of restructuring is not available upfront, it should be possible to recover this later, out of the value that can be created by the restructuring. The need to minimise the burden of such cost, preferably initially, but certainly finally is obvious and cannot be overstated. Any plan for restructuring which does not clearly result in value addition at the end of the exercise, is not worth attempting. c. All concerned must share losses: The restructuring strategy as also the instruments employed in the implementation of this strategy have to make a clear statement about the manner in which the losses already incurred and to be incurred have to be shared. The principle of sharing of losses will have to remain fully operative in both operational and financial restructuring envisaged for a bank. Such a plan for sharing losses will include

reduction in staff as well as all other administrative cost of operations. d. Changes for strong internal governance: The internal governance of the bank and its operations at all levels have to be strengthened and fully sensitised to the needs of protecting against all foreseeable future problems. Restructuring always involves some amount of destabilisation in the organisation and during this period as also immediately after it, management and all its operatives have to make sure that the intended benefits of the restructuring plans are not allowed in any way to be frittered away or lost due to delays and lack of diligence in its implementation. e. Effective monitoring and timely course corrections: Individual restructuring plans are to be implemented by the banks concerned internally and their success will depend upon the quality of governance and organisational commitment to the proposed restructuring. However, for a successful restructuring it is important that there is an independent agency which will own it and in the process of driving it forth, constantly monitor its progress. This role can be played by the owner but such an arrangement has limitations because of the conflict of interests that is likely to arise in such cases and the lack of time and skill for the job, which the owner may suffer from. It will be more so when the ownership of the banks is with the government. For obvious reasons, this responsibility cannot be given to the regulator either. The regulator will no doubt have interest in the success of the restructuring programme but direct efforts on its part to ensure its implementation could result in conflict of interests. The objective can, therefore, be best achieved by an independent agency, which with the express consent of the owner shall have full authority over the restructuring process and be in a position to effectively monitor its progress. In this process, while this independent agency will monitor to ensure that the restructuring process remains on course, wherever necessary it shall also take steps to facilitate due implementation of the plan. Such steps by this agency may include devising corrective measures and ensuring that the banks concerned adopt these measures. f. Ease of implementation: Above all there must be an all-round consensus on the process of restructuring, its modalities and timing. The process itself and all the attendant instruments and instrumentalities will have to be simple and easy to employ. 7.5 While setting the core principles, which should govern any programme of bank restructuring, is not so difficult, deciding upon precise modalities of restructuring is, indeed, quite a vexatious and difficult issue to settle. As can be learnt from international experiences various modalities and quite a few variations of each of these modalities have been tried with varying degrees of success. In their time and given socio-economic environment each of these options chosen had good logic behind them. While, therefore, they have their applicability and merit these are certainly not transplantable where the prevailing conditions are different. 7.6 Mainly bank restructuring has been attempted using one of the undermentioned four modalities. Sometimes a combination of one or more thereof has also been tried. These are: a. merger or closure, b. change in ownership sometimes from private to government, but more often than not from government to private owners, c. narrow banking, d. comprehensive operational and financial restructuring of existing units.

7.7 In the following paragraphs, the applicability of each of the above options in the present Indian context, has been examined with a view to selecting the one which at this point of time is most suited to the socio-economic conditions prevailing and, therefore, has the best chance to succeed. Merger or closure 7.8 Merger between two banks and for that matter any two entities would be of any advantage only if it takes into account the synergies and complementarities of the merging units and provides opportunities for pooling of strengths. The overall reduction in cost of operations of the merged entity ensures improved operational efficiency and greatly enhances its competitive abilities. Mergers and acquisitions, world over, have, therefore, been primarily volume driven and often in response to the competition or environmental necessities. Often the objectives of merger are consolidation, better positioning and larger market share. In this quest, rationalisation of business lines, staff strength and the administrative structure are common and sacrifices in the merging units are unavoidable. The socio-economic environment in India does not, however, permit such changes to be made easily. 7.9 The problem gets compounded if, of the two units merging, one is already suffering from serious operational deficiencies and is merging with another comparatively larger unit merely to save its existence albeit in a modified form. In such a situation, while the weak unit merges its deficiencies in the stronger unit, the merged entity does not get any opportunity to avail of post-merger advantages. As a result, the merged unit itself becomes weak and often loses its competitive abilities. 7.10 The experience of bank mergers in the public sector has so far been limited to that of New Bank of India with the comparatively strong Punjab National Bank in 1993. The result of this merger was no different from the worst apprehensions expressed above. A direct result of the merger was that Punjab National Bank, a strong bank with uninterrupted record of profits, had to record a net loss in 1996 of Rs. 95.90 crore. The bank also had to face litigation and other problems especially relating to service conditions of the personnel taken over some of which are still persisting. The merger clearly demonstrated the futility of merging banks with different work cultures, ethic and skill levels of the employees whereby even the stronger bank was put to severe stress. Till today little evidence is available of any worthwhile advantage having accrued to Punjab National Bank from the merger. 7.11 The Working Group is, therefore, of the view that mergers even between two strong banks would serve any purpose only if it can be quickly followed by advantageous restructuring resulting in sizeable cost reduction and a markedly higher share in business and profits. Merger between two weak banks would serve no purpose whatsoever and if at all a plan of giving the two entities a wider geographical or business spread is to be worked out, the concerned banks working will have to be first brought to a minimum level of competitive efficiency. It would then be possible for the merged entity to have a fighting chance of survival and not sink under the weight of its own heightened inefficiency. Given the present scenario, merger of a weak bank with another weak bank or with any other stronger bank would be totally counterproductive. The Working Group, therefore, does not recommend merger as a possible Solution for reviving the weak banks without first restructuring them. 7.12 Closure has a number of negative externalities affecting depositors, Borrowers, other clients, employees and, in general, the areas served by the banks being closed. Besides the misery that it will bring to the depositors, a large number of the borrowing clients of banks

under closure also could run into Difficulties and their businesses may suffer causing substantial economic loss. The overall cost of closure, therefore, is always high. This is an extreme option and would need to be exercised only after all other options of successful restructuring have been ruled out. Change in ownership 7.13 International experience shows that diluting or completely removing government ownership of financial institutions is one of the commonly used strategies in bank restructuring. Such transfer of ownership may be to existing reputed corporate groups or to foreign banks or others. 7.14 The Working Group considered the option of privatisation in the context of restructuring weak banks and feels that privatisation is a desirable objective in the long run. It would have the following benefits: a. The government will be able to recoup, wholly or partly, the cost incurred by it for restructuring these and other banks. As a result,the ultimate burden on the fiscal budget is reduced considerably. b. The moral hazard contained in the implicit assurance that government support will always be available is removed. c. Limitations in adopting a unit-specific policy with regard to recruitment, compensation, technology, deployment of resources, etc. are removed. d. The performance of the privatised units becomes more market- driven and, as a result, its management shows greater accountability in meeting the expectations of its different stakeholders. 7.15 The Working Group is of the view that privatisation is a good option for restructuring weak banks in the Indian context as well. However, privatisation of weak banks at this stage is unlikely to be successful for the following reasons: a. The cost of restructuring weak banks is prohibitive and no private group can normally be expected to bring in the kind of resources that are required. b. The banks are not likely to access the capital market successfully given their present financial state. c. The present staffing pattern, the level of available skills and lack of technological sophistication are likely to act as deterrents to any private or foreign investors. Restructuring through privatisation can, therefore, be undertaken only after the above issues have been sorted out. Without attending to these, even if a privatisation plan succeeds, it is likely to prove very expensive. With the banks in their current shape, the government may not be able to recover much value for the very sizeable amount of capital it has invested. Narrow Banking 7.16 Narrow banking, as an option for restructuring weak banks in India, has been a subject of serious debate and discussion for some time. The suggestion was first made by the Committee on Capital Account Convertibility, which proposed that the incremental resources of these narrow banks should be restricted only to investments in government securities and in extreme cases of weaknesses, not only should such banks not be allowed to increase their advances but there would need to be a severe restraint on their liability

growth.10 7.17 In a slight variation, narrow banking has also been described as a situation where a bank which is weak should taper down its incremental credit- deposit ratio the weaker the bank, the lower the incremental credit deposit ratio.11 This definition gives a little extra room for credit but all the same is restrictive. It may be noted in this context that all the three weak banks have pursued some form of narrow banking, as defined above, for reasons such as inability to lend to quality customers, as a matter of deliberate policy, high levels of NPAs and what has been termed as fear psychosis. 7.18 The practice of preferring government securities to fresh lendings has led to several cases of dissatisfied borrowers who were denied credit. Such dissatisfied borrowers, without fail, look for alternatives and finally, as soon as they are able to develop a new banking connection, change their bank. 7.19 Banks ability to generate non-interest income is closely linked to the size and quality of their advances portfolio. A restriction on this portfolio invariably results in fall in fee income. Such a two-pronged loss in income adds to the weakness of the bank making its recovery even more difficult. In the case of the weak banks, slowdown in advances has already affected growth of their fee income. This will make their recovery even more difficult. 7.20 In the Working Groups view, the argument for pursuing a policy of narrow banking does not take into account the fact that government securities are also subject to market risks and that banks have to make necessary provisions for such risks. Dependence on a single stream of income by way of interest on government securities also exposes them to serious interest rate risks. Further, narrow banking entails a somewhat inefficient use of available resources. 7.21 It is well known that in a banking organisation, credit culture cannot be introduced or discontinued at will. A break in this culture during a period of credit refusals can do untold damage to institutions where, unlike those abroad, personnel at various levels of employment cannot be moved in and out depending upon changes in the business strategy. 7.22 The entire rationale for narrow banking rests on the premise that the weak banks do not have an efficient credit management team and that further advances made by them are most likely to end up as NPAs. While there are indeed gaps in skills, the Working Group feels that these need to be addressed separately and not by curbing growth in advances. In any case, narrow banking can, at best, be only a temporary phase and cannot by itself be adopted as a restructuring strategy. Comprehensive operational and financial restructuring 7.23 With the three other options not being found suitable to the present environment, the only alternative left for consideration is that of comprehensive operational and financial restructuring. Therefore, the Group has tried to answer the question whether the option of restructuring is available in the case of the three identified weak banks. 7.24 The three banks are obviously beset with serious weaknesses. They have lost their competitive ability and are very seriously handicapped. Although through the entire 90s,

each one of them has been recapitalised almost every year, with a total sum of Rs. 6,740 crore, they have still not been able to turn around and continue to depend on further capitalisation by the government. Indian Bank alone will need about another Rs. 1,000 crore urgently to gain the minimum prescribed capital adequacy of nine per cent with no guarantee that, at the end of the current year, once again they will not need further infusion of capital to maintain this ratio. The position of the other two is only marginally better as they do not need capital infusion immediately. However, their future operations too are unlikely to continue without further infusion of capital. It does not, therefore, make economic sense to let them continue in the present manner for, after all, the government cannot undertake to capitalise them endlessly. 7.25 A time has, therefore, come to take a long term view and to ensure that the present state of affairs does not get prolonged. The choice, therefore, is limited to either closing them or subjecting them to such extensive operational, organisational and financial restructuring as will completely change their cost structure and mode of operations and turn them into banks with minimum competitive efficiency capable of continuing their operations without any further external help. 7.26 As stated earlier, the Group is of the view that closure of banks, especially those with very extensive networks and large client base, as is the case with each of the three banks under consideration, must always be the last option. In the opinion of the Working Group, therefore, the choice of comprehensive restructuring deserves careful consideration. Any such restructuring, however, will mean exercising hard options and involve firm, decisive and timely actions. For this, there has to be a clear commitment from the owner, the government. It must display firm political will and generate an all-round consensus that the restructuring will go ahead without let or hindrance. The management of the banks and the employee unions will have to come to an agreement before the restructuring exercise begins as regards every important ingredient of the proposed exercise. The crux of the issue is that it is going to be an expensive one-time exercise and, unless its success is reasonably assured, it will not be worth undertaking. 7.27 It is, however, to be recognised that options of merger and/or privatisation as time tested remedies are not to be ruled out per se as restructuring options unavailable to weak banks. The Group is fully conscious that these strategies would become increasingly relevant in the years to come when further deregulation and competition would inevitably point to the need for consolidation for survival. In the interim, however, restructuring of the weak banks would necessarily have to be a comprehensive but largely internal exercise. 7.28 The Group has developed for the three banks a four-dimensional comprehensive restructuring programme covering operational, organisational, financial and systemic restructuring. These are as under: 1. Operational restructuring involving (i) basic changes in the mode of operations resulting in diversification of sources of income and increase therein, adoption of modern technology,

(ii)

(iii)

resolution of the problem of high non-performing assets and the resultant loss of income, and drastic reduction in cost of operations.

(iv)

2. Organisational restructuring aimed at improved governance of the banks and enhancement in management involvement and efficiency. 3. Financial restructuring with conditional recapitalisation. 4. Systemic restructuring providing for, inter alia, legal changes and institution building for supporting the restructuring process. In the opinion of the Group, subject to its receiving the kind of acceptability and support envisaged in paragraph 7.26 above, the restructuring could restore the three banks to health and efficiency. 7.29 The Group is of the view that the restructuring of the weak banks could well be a twostage operation. In stage one, focus will be on operational, organisational and financial restructuring of the units involved aimed at restoring their competitive efficiency. In stage two of restructuring, the options of privatisation or mergers will assume relevance. The banks would have, by then, turned into self-supporting banks and could command, on their own, investor attention as good investment options. 7.30 In the three banks, which have already been identified as weak, viz., Indian Bank, UCO Bank and United Bank of India, structural as well as operational weaknesses have been most persistent and pronounced. As detailed in Chapter 5, various efforts were made in the past to study and find solutions to their problems. These studies provide a ready insight into the problems as also the nature of solutions offered and the reasons for which these solutions have so far either failed or succeeded only partially. In view of this and due to the limited time and resources available the Group could realistically focus its attention only on the three banks for the purpose of suggesting specific measures of restructuring. 7.31 The Group hopes that the broad pattern of strategies proposed on the basis of its approach as detailed in the following paragraphs for restructuring the three banks and the experience that would be gained in these exercises would facilitate evolution of a restructuring strategy for other banks as well which show signs of distress. Operational Restructuring 7.32 Going by the international experience, Garcia12 has identified the following as the key elements of operational restructuring of banks: a. Formulating a business plan that focuses on core products and competencies. b. Reducing operating costs by cutting staff and eliminating branches where appropriate, ceasing unprofitable activities, and disposing of unproductive assets. c. Implementing new technology and improving systems of accounting, asset valuation, and internal controls and audit.

d. Establishing and enforcing internal procedures for risk pricing, credit assessment and approval, monitoring the condition of borrowers, ensuring payment of interest and principal, and active loan recovery. e. Creating internal incentive structures to align the interests of directors, managers, and staff with those of the owners. The Working Group considers the above to be a very good and concise statement of operational restructuring requirements. The plan evolved by the Working Group for restructuring of the three banks is also on similar lines. 7.33 The approach adopted by the Working Group in suggesting operational restructuring plan for the weak banks is two pronged: one of increasing income and the other of reducing costs. The objective of increasing income in its turn has to be achieved on the one hand by revamping the banks mode of doing business and on the other by making suitable arrangements to reduce to the minimum the effect of current and future NPAs on their earnings. Cost reduction will have to be achieved by dropping the lines of business and products which are proving a drag on their profitability and also by putting every significant cost item including staff cost under the strictest scrutiny with a view to reducing it without, of course, affecting the required level of efficiency. For this purpose, it would be necessary to set benchmarks for achievements. These would be available by looking at the benchmarks set by peers and competitors. A serious and continued deviation from these benchmarks would only mean that the three banks will not be competitive and, in the end, lose out in the race totally. Revamping the mode of doing business 7.34 In the situation the weak banks find themselves, the first thing that they need to do is to retain their business and client base and protect themselves against the possibility of being swiftly and completely overtaken by the competition. The most prominent shortcoming of the weak banks is the quality of their service and its limited range. The banking products offered by them are outdated and are being used mostly by that segment of clientele the relationship with which is least remunerative. Both on the asset and liabilities sides of their balance sheet, there is practically no product innovation and high cost of their operations is precluding them from pricing any of their products attractively. 7.35 In the interest of their survival, the three banks cannot afford to lose any further share in the overall business and require to develop urgently capabilities to launch new products, attract new customers and bring about an overall improvement in housekeeping, MIS and risk management. Developing a special business focus 7.36 The Working Group found that all the three banks were trying to do everything everywhere without developing any special skills or strengths in chosen areas. None of them is identified with any special business or customer niche in which it has in the past been especially successful or could be so in future. Such business strategy as they may have lacks focus and, therefore, produces little results. Each of them, therefore, needs to develop strengths in chosen areas and build its skills and business strategy around those strengths. All

these three banks, particularly, United Bank of India and Indian Bank, have concentration of branches in a few states but, instead of devising strategies of making the most of that particular market, are insisting on assuming the character of large all-India banks. In the bargain, they are having the worst of both the worlds for they are neither any more dominant in the area of concentration nor are they able to make a mark countrywide. Diversification of sources of income 7.37 As has been mentioned earlier, in some ways, all these three banks have been operating in the recent past as narrow banks relying more and more on investments in government securities as avenues for deployment of their funds. The growth of their credit portfolios has been extremely limited and fee-based earnings have been minimal. They need to take urgent steps to reintroduce credit culture and ensure a rapid growth in non-fund based earnings. The large network of branches which the three banks have can be leveraged well to increase fee-based earnings by merely laying stress on a few selected services, particularly, movement and management of funds. 7.38 It is obviously not possible for any bank to avoid credit business for long. Their selection of credit business in the few years preceding their becoming weak proved to be adverse largely because they left the traditional areas of business in which they had experience and moved into areas for which they neither had built skills nor had any past experience. They must, therefore, now select areas of credit in which they have had experience and those relating to which it is possible for them to develop expertise within a short time. The appropriate markets for them will be the middle and lower segments of the credit market. They need to concentrate more on the retail end of the business rather than large scale which has been their undoing. 7.39 As a means of increasing their income, management and unions of the three banks have put forward a plea for allocation of a share of business related to good PSUs and other government departments to them. They have argued that most such business goes to larger banks and that they are deprived of what they consider a rightful share. In the opinion of the Working Group, such an approach is neither practical nor desirable. The banks need to learn to withstand competition. In a deregulated environment, to take a step as suggested by them would be retrograde and going by the overall results counterproductive for the system. At the present stage of financial sector reforms, an arrangement for transferring good clientele by giving directives can be seen only as a step towards reversal of reforms. Moreover, the companies/corporations whose business is sought to be so transferred are themselves autonomous bodies and would assess their benefits before transferring their business from their present bankers to another. Banks which are at present not able to meet the clients expectations of quality and cost on competitive grounds can hardly expect to get any new business by an administrative fiat. The Working Group, therefore, feels strongly that acquisition of competitive efficiencies is the only way for the banks to broaden their business base and to attract to their books blue chip PSUs or other remunerative clients. Unprofitable operations which need to be shed 7.40 Two of the three weak banks have operations which are clearly not profitable and may prove to be a big burden on their future operations. These are their operations abroad and operations through subsidiaries. While UCO Bank and Indian Bank have their branches abroad, the latter has three subsidiaries for merchant banking, housing finance and managing mutual funds. The two banks need to pull out of these two areas without any further loss of time.

7.41 While it has been commonly argued that these operations are profitable and that even if there are temporary hiccups they remain profitable without affecting the banks balance sheet adversely, this is actually not borne out by facts. Such arguments have limited validity viewed in the context that operating environments abroad are far more volatile and the quality of asset books of most Indian banks is not above average and is open to far greater risks than any comparable operation in India. The table below shows the operating results of foreign branches of UCO Bank and Indian Bank together with the position in regard to their NPAs. Table 11: Performance of foreign branches (Amt. in Rs. crore) Name of the Bank/branch Net Profit remitted Profit/Loss to India 97-98 98-99 Indian Bank a. Singapore b. Colombo (FCBU) c. Colombo (DU) UCO Bank a. Singapore i. Singapore Main ii. Serangoon Rd. b. Hongkong i. Hongkong Main ii. Kowloon c. UK Centre @ Centre Centre 43.71 (-)0.13 0.10 0.50 2.16 0.22 0.82 97-98 98-99 Gross NPAs Remittances from HO to branch 97-98 98-99 25.27

97-98

98-99

332.73 517.26 62.40 68.29 3.96 3.34

19.60 14.47 (-)0.21 0.42

36.22 4.38

39.90 10.30

4.73 4.55 0.44

5.26 2.46 (-) 20.62

29.64 13.49

46.83 21.79 48.90

136.25

Note: @ London branch since closed. It would be clear from the above that both UCO Bank and Indian Bank would find it extremely difficult to run these branches in the short and medium term. The position even now is tenuous and would get exacerbated if any of these operations runs into the slightest of difficulty. Even if they do not, the local regulators going by the present condition of the two banks could stipulate serious conditions regarding capital adequacy or administration of these branches which the banks are not likely to be able to meet. A sudden emergence of such a situation could pose a problem for not only the two banks but also for the Indian banking system. In 1998-99, Indian Bank had to remit Rs. 25.27 crore to Colombo to support its operations. UCO Bank too had to remit Rs. 43.71 crore to London where its branch was closed. 7.42 Since the foreign operations of the two banks have, at best, only marginal profitability, the Working Group is of the opinion that they need to be taken off the hands of the two banks notwithstanding any reservation that they may have on this score. These could be sold to prospective buyers including other Indian public sector banks subject to the necessary approvals. The resources raised could fund some of the various demands of the

restructuring operations. 7.43 Indian Bank has three subsidiaries, viz., Indbank Merchant Banking Services Ltd. (IBMBS), IndBank Housing Ltd. (IBHL) and IndFund Management Ltd. (IFML). Of these, the first two subsidiaries are owned partly by Indian Bank and the third is fully owned. The IBMBS generated a meagre profit of Rs. 1.23 crore in 1996-97 and Rs. 1.20 crore in 1997-98 while the other two subsidiaries have been facing financial problems in the last two years. The inability of IFML to meet returns assured in one mutual fund scheme had to be made good to the extent of Rs. 43 crore by the parent bank as per SEBI directive. Likely losses on another assured return scheme, requiring to be foreclosed, would also devolve on the bank soon. Indian Bank was required to contribute Rs. 13.40 crore to IBHL during the year 199899 to enhance its capital adequacy ratio to eight per cent as prescribed by the National Housing Bank. Besides, the housing subsidiary has also suffered deterioration in its assets portfolio on account of investment in certain Inter Corporate Deposits placed with the borrowers of the parent bank which have since turned bad. The cumulative burden on account of the above developments will have to be passed on to the owners, i.e., the Government of India, since the bank itself is totally dependent on further infusion of capital by the government. 7.44 The Working Group is of the view that the subsidiaries of Indian Bank are likely to be a continued drag on its own viability and would add to the cost of restructuring. A decision to pull out of these needs to be taken by the bank at the earliest as part of the restructuring. The bank needs to concentrate on its core activities and redesign its business line in a manner that will reduce the need for further capital. An effort could also be made to find buyers for the banks holdings in the subsidiaries care, however, being taken that the issue is not allowed to prolong. Adoption of modern technology 7.45 Any meaningful revamp of the mode of doing business in public sector banks is not possible unless they are in a position to adopt modern banking technology urgently. Some efforts have been made in the three weak banks as well but these are insignificant viewed in the context of what competition is doing. 7.46 New private sector banks and foreign banks are now in a position to offer highly sophisticated and technology oriented products and services to their customers. Some leading public sector banks too have changed their technology substantially and achieved noticeable success in offering at least some of the modern banking products. Such products and use of technology not only make a bank customer friendly but also increase its capacity to handle much larger volume of business efficiently and thereby reduce service charges. 7.47 The rate of growth of business of banks using modern technology has so far been extremely fast and is likely to gain further momentum as the use of banking technology spreads out of metropolitan cities into smaller towns. The new private sector and foreign banks which have in the past four to five years gained over eight per cent each of the entire banking business available are now likely to increase their share at a faster pace. This will be at the cost of the older and larger banks and the weaker ones amongst them will be the biggest sufferers. There is little indication that, on their own, they will be able to adopt modern technology in the near future which implies that, in the next few years, their inability to attract new clients and retain the existing remunerative ones will make their position even more untenable. Urgent steps have to be, therefore, taken to alter this position.

7.48 In the Working Groups view, a technology initiative has to be necessarily the starting point for the restructuring process. Unfortunately, however, the three weak banks just do not have the physical, financial and human resources to define, design, implement, manage and maintain complex IT solutions of the kind that are required to meet the challenges posed by new players as well as the more efficient of the existing players in the market. It is this limitation which has so far caused a lukewarm attitude towards modern technology in the three banks. For them, therefore, a special solution needs to be found on an urgent basis. 7.49 Both because of the limitations of staff and skills mentioned above and the high costs involved in building up separate infrastructure for the three banks, the Working Group is of the view that a desirable solution for these three banks would be to have common networking and processing facilities. Alternatively, the three banks, depending on geographical factors could consider tying up with other banks, which have not been as yet identified as weak, for greater strategic advantage. Such sharing is beneficial because it leads to lower costs and greater efficiency of operations. State-of-the-art technology can be obtained at affordable prices. It would enable the three banks to bring into their operations, at an earlier date than would otherwise be possible, modern banking products like anywhere banking and anytime banking, telebanking, electronic data interchange (EDI) and internet banking. 7.50 In the situation that the weak banks find themselves, it would be best for them that such common facilities be outsourced from an existing reputed company, which will run the system for them. The main benefit of such outsourcing will be that it will enable the three banks to get over the problem of an almost total lack of skills in these areas. Besides, such outsourcing will enable them to get the facilities upgraded whenever needed in a far more timely and cost-efficient manner than if they were to manage their respective facilities on their own. Under this arrangement, while the banks would own the hardware and the software licensed to them, managing of the system would be done by the outside agency. The service provider could also be invited to follow a Build Own Operate Transfer model for this purpose. This agency, as a facilitator, would provide the common communications infrastructure for networking, etc., and be expected to do the following: a. identify the IT requirements of the participating banks, b. design total IT solutions that meet the above requirements, c. implement the solution in consultation with the participating banks, d. actively participate in the procurement and installation of all necessary hardware and other equipment, e. manage and maintain the systems, f. adapt IT to changing technology and business needs, g. evolve new technology-based products, h. train all staff identified to function in the new environment. Implementation of an IT solution in the aforesaid manner is expected 7.51 to yield the following benefits: a. facilitate bank-wide risk management, asset-liability management and profitability analysis, help integrate the domestic and forex treasuries with the rest of the bank, provide a common IT-related management talent,

b.

c.

d. e. f.

provide access to technical skills, enable introduction of extended working hours and shifts, improve overall customer service in the banks.

7.52 Gearing up an entire bank to work in an IT-driven environment will take time. Therefore, this process has to necessarily go through different stages. The Working Group feels that in the first stage of implementation itself, which may be spread over twelve to eighteen months, the IT solutions should target coverage of over 70 per cent of the participating banks present business. This would require that around 250 to 300 of the largest branches from each of the three banks be linked to the proposed outsourcing of technology requirements. 7.53 The Working Group obtained the views of Infosys Technologies Ltd. (ITL), which has considerable experience in providing IT solutions to Indian banks, to arrive at a realistic estimate of the level of investment that would be required to implement the above strategy. Taking into view the estimates provided by ITL and also the extent of technology induction that would be required, the Working Group has estimated the total cost at around Rs. 300 crore. This will cover the cost of implementing the solution at 300 branches each from the three banks and the cost of central hubs and about 600 ATM switch and telebanking points. It excludes the cost of PCs, which may already be available to a large extent, cost of training and other recurring costs. In order to cut costs, while actually implementing the IT solution, the banks may consider the feasibility of utilising the excess capacity available with the already existing networks. 7.54 Obviously, the three banks will not be in a position to bear the cost of implementing the above recommendation and would, therefore, require government assistance in this regard. Such assistance may come in the form of further capitalisation for the three banks specifically earmarked for this purpose. Elsewhere in this chapter, the Group has made recommendations about the aggregate additional recapitalisation required for the three banks. In that context, it has already been suggested that further capitalisation may have to be earmarked for specific purposes. This recommendation is in line with the proposal. 7.55 It may also be added that assistance for modernisation initiatives is also available from multilateral agencies. The Group had an occasion to discuss this issue with the representatives of World Bank when they were visiting India in connection with the monitoring of one of the loans sanctioned by them of which Indian Bank is one of the beneficiaries. The impression gathered by the Group from the discussion was that World Bank assistance for this purpose may be feasible. This source of funding would also be worth exploring. Reduction of NPAs 7.56 NPAs have been the single most vexing problem faced by the public sector banks. Banks that have been identified as weak are mainly so because of the loss of their income, high carrying costs of NPAs both in terms of their funding as well as provisioning and the general stagnation of operations caused by the NPAs in their books. The position of NPAs in Indian Bank, UCO Bank and United Bank of India and their movement during the three years 1996-97 to 1998-99 is furnished in Table 12. It may be seen from the table that the aggregate NPAs of Indian Bank and United Bank of India have been rising in the last three years while

that of UCO Bank showed marginal decline during the period. Noticeably, additions to NPAs in the Indian Bank outstripped recoveries in all the three years. Table 12: Movement in level of NPAs (Rs. crore) Gross NPAs at beginning of the year Indian Bank 1996-97 1997-98 1998-99 UCO Bank 1996-97 1997-98 1998-99 United Bank of India 1996-97 3,140 (34.15) 3,303 (39.12) 3,428 (38.96) 1,840 (24.54) 1,873 (28.35) 1,780 (24.04) Recoveries made during the year 482 347 164 Addition to NPAs during the year 645 472 445 Closing balance

3,303 (39.12) 3,428 (38.96) 3,709 (38.70) 1,873 (28.35) 1,780 (24.04) 1,716 (22.55)

354 371 327

387 278 263

1,401 167 164 1,398 (38.00) (36.20) 1997-98 1,398 97 150 1,451 (36.20) (33.50) 1998-99 1,451 101 199 1,549 (33.50) (32.39) Note: Figures in brackets indicate percentage of Gross NPAs to Gross Advances. 7.57 A sizeable portion of the aggregate NPA with the public sector banks is that of chronic NPAs, i.e., loans which have remained as non-performing in their books for several years in some cases running into decades. Besides, a significant portion of the NPAs is locked in legal proceedings or in the BIFR and cannot be expected to be recovered in the foreseeable future. There are also loans given to state or central public sector units which they have failed to repay. These loans are both with or without government guarantees. The banks have found it difficult to proceed against these units and recover their dues even where there are government guarantees. The table below gives the details of such chronic NPAs of the three weak banks as on 31 March 1999. Table 13: Details of chronic NPAs as on 31 March 1999 (Rs. crore) Indian Bank 465.49 2,767.04 44.00 0.85 UCO Bank 200.08 573.68 213.79 91.90 United Bank of India 238.95 272.00 365.00 58.64

a. BIFR b. Suit filed cases @ i. With DRT ii. With courts c. Dues from PSUs i. With government

guarantee ii. Without 12.13 government guarantee @ includes cases decreed but not executed.

6.98

7.58 Chronic NPAs are likely to prove a big handicap in the revival of weak banks and it is therefore necessary that measures are found to ensure their resolution at an early date. As is known, while setting up of BIFR has helped in some ways, in some other its operations have proved disadvantageous to banks in recovery of their dues. Cases in which borrowers have engineered to take the shelter of BIFR to avoid recovery proceedings are not uncommon. Also, BIFR proceedings, for various reasons, do take a long time during which while all recovery proceedings against a borrowing unit come to a standstill, it retains control of all its assets and continues to deal with them freely. This often leads to weakening and/or loss of the banks securities/ collaterals for the advance and reduces chances of recovery. While amendments to the Sick Industrial Companies Act, 1985, are being considered to take care of some of the concerns mentioned above, these have been a long time in coming. 7.59 Although the setting up of Debt Recovery Tribunals had raised much hopes about speeding up of the recovery proceedings initiated by banks these hopes have largely remained unfulfilled. At quite a few places, the DRTs are still to be set up and, even where these have been set up, they are not yet fully equipped to handle very large number of cases already before them or those that can be placed before them. In some of the DRTs, the number of pending cases is now quite large. While the government has been reviewing the operations of DRTs, as yet a stage has not come when it can be said that these are helping recoveries of banks dues substantially. 7.60 The dues with public sector units pose their own problems of recovery. While in recent years there has been some change in the attitude, the response of the borrowing units to the banks efforts towards recovery of their dues has largely been negative presumably because of their government ownership. The situation has not been much different even where these loans are guaranteed by the state or the central government. The Group is of the view that where guarantees have been given by the central or state governments and a demand thereunder has been raised by the banks, these demands need to be met. It may be mentioned in this context that with effect from the year beginning 1 April 2000, banks will be required to make provisions against non-performing loans even if these bear state government guarantees. 7.61 In recent years, public sector banks have resorted to compromises as one of the means of reducing NPAs on their books. While some progress has been achieved through this route, it has actually been limited. This has largely been due to the apprehensions on the part of the banks about the terms of compromise being challenged. These apprehensions have grown in intensity as quite often there have been allegations from different quarters about the compromises not being fair or undue favour having been shown to the borrower. Fears of such allegations and subsequent intervention by investigating agencies has been a big block in the way of compromises being arrived at in some banks. In weak banks, where the NPAs are high and the level of confidence is low, compromises are more often than not, being avoided. An effort was made in some banks to get over these hesitations by setting up Settlement Advisory Committees (SAC) headed by an independent retired high court judge and aided by a senior retired bank official to help arriving at compromises. It was hoped that

compromise figures/terms arrived at with the help of SACs will not be open to many questions and the banks will be able to go ahead with the compromises with greater confidence. This has not always happened as the banks have not had the confidence to go ahead with the compromises especially in the case of larger loans. 7.62 It is necessary that this otherwise effective measure be used to greater effect by the weak banks in reducing their NPAs. In the light of the experience gained so far, it would be desirable for the Boards of the three banks to lay down clearly their expectations in most cases of compromise. As long as the recommendations of the SAC match these outlines, there should be no case for delaying compromises it recommends on the general ground that these could be improved. A greater reliance must be placed upon the recommendations of the SACs in order to make a better use of compromises for reduction of NPAs in the banks books. Separating NPAs from weak banks 7.63 The quickest and possibly the most effective way of removing NPAs from the books of the weak banks would be to move these out to a separate agency which will buy these loans from the banks and make its own efforts for their recovery. Separate institutional arrangements for taking over problem loans have played a key part in bank restructuring in different countries with varying degrees of success. To name a few, these include the Resolution Trust Corporation in the USA, Securum and Retriva in Sweden, the Cooperative Credit Purchase Company, the Resolution and Collection Bank and the Housing Loan Administration Corporation in Japan, and the Korea Asset Management Corporation in Korea. There has been no uniformity in either the structure or mode of operations of these companies. These differed according to whether these were government owned or privately owned and whether these were set up for one bank, a group/class of banks or for the whole system. Some were given a fixed time limit for completing their operations while certain others have been set up to function on an ongoing basis. Their relative successes, however, depended on the extent to which their operations were structured to suit the local conditions. 7.64 The Committee on Financial System (1991) had suggested setting up of an Asset Reconstruction Fund and, as an alternative thereto, the CBSR (1998) recommended transfer of these assets to an Asset Reconstruction Company. A special Group was also set up by the Government of India in July 1998 for suggesting an operating plan for setting up Asset Reconstruction Companies. The present Working Group too has seen separation of NPAs as an important element in a comprehensive restructuring strategy for weak banks and considers this mechanism to be an acceptable solution to the problem of accumulated NPAs and the resultant strain on profitability of banks. 7.65 Selection of a proper financial vehicle through which non-performing loans can be transferred out of the weak banks books is the key issue. After due consideration, the Working Group has come to the conclusion that in our situation it would be desirable to develop a structure which will combine the advantages of government ownership and private enterprise. The broad structure would be that of a government-owned Asset Reconstruction Fund (ARF) managed by an independent private sector Asset Management Company (AMC). The key elements of this structure and its operational details are discussed below. A two-tier ownership management structure 7.66 Assets belonging to public sector banks can be transferred with least complications to

a public sector body/agency. Considering the size of the capital that will be needed for this exercise, the problems relating to pricing of the assets to be transferred, the desirability of making these transfers unchallengeable by the borrower or anyone else and the urgent need for changes in the available legal framework so that early enforcement of the lenders rights becomes possible, it would be best if the ownership of the transferred assets lies with the government. However, the government body owning the assets may not possess the necessary skills and attitude to ensure their recovery and it may suffer from the limitations which most public sector units suffer. It is, therefore, proposed to have a two-tier ownership management structure in which the ownership of the assets will lie with the government and the management thereof with a separate private sector entity having the necessary expertise and organisation. Being in the private sector it will have the managerial and operational flexibility which the public sector units do not normally have and will be able to employ/hire the needed expertise. Asset Reconstruction Fund 7.67 The ARF will be constituted with the objective of buying impaired loans from the weak banks and to recover or sell them after some reconstruction or in an as is where is condition. The ARF will be a profit-oriented operation, its aim being to recover from the acquired assets (NPAs) more than the price paid for it. 7.68 The ARF may be set up by the Financial Restructuring Authority (FRA, discussed in greater detail in paragraphs 7.143 to 7.147) under a special Act of the Parliament. The Act, while protecting it against obstructive litigation from the borrowers could also provide for quick and effective enforcement of its rights against them. Some such special rights are enjoyed by State Financial Corporations (SFCs) and were also incorporated in the Industrial Reconstruction Bank of India Act under which the IRBI was constituted. The proposed fresh enactment would need to place the ARF in a better position to recover the loans as compared to the banks, SFCs and the erstwhile IRBI, for it is only then that the government will be successful in recovering at least a portion of the NPAs which the banks failed to recover. Capital required for the ARF 7.69 Since under the proposed structure the ownership of the assets is sought to be kept with the government, the capital for the ARF would need to come from the government sources. However, the structure also retains the possibility of other institutional investors joining hands with government in providing capital for the ARF. They can join either initially as the ARF is being set up or any time later subject to the governments concurrence. The size of the capital needed for the ARF will depend upon the decision that is taken about the size of business it will handle. Presently, it is proposed that the ARF may restrict its activities to the NPAs of the three identified weak banks although it may also retain the option of dealing with NPAs of any other bank. This option may need to be exercised while considering taking over of a loan provided by banks in a consortium. 7.70 The NPAs of Indian Bank, UCO Bank and United Bank of India together amounted to Rs. 6,974 crore as on 31 March 1999. The Group feels that in order to ensure effective follow up and recovery of assets acquired, the ARF should, in the initial stages, focus on comparatively larger NPAs. It would, therefore, be desirable not to acquire assets valued below a minimum amount prescribed. To start with, this minimum amount may be kept at Rs. 50 lakh. Such NPAs of the three banks aggregated Rs. 3,336 crore as on 31 March 1999. 7.71 The ARF may, therefore, be required to acquire assets of the face value of about Rs.

3,000 crore. Past experiences of recoveries of bad loans indicate that it is generally possible to recover from loans which are more than three years old about 30 to 35 per cent of their face value. Recent experiences in South East Asian countries also have been similar and, presently, in Korea, the Korea Asset Management Corporation is reported to be buying secured impaired loans for 36 per cent of their face value. In other countries where the auction route has been adopted, such auctions have also fetched for bad loan prices in the range of 28 to 35 per cent of their face value. While conditions differ from country to country and prices will of course vary depending upon the quality of the NPA and the recovery environment, the Group feels that in our conditions also, as has already been experienced, average recovery remains within the range of 35 to 40 per cent of the outstandings. The price the ARF may be expected to pay would, therefore, be in this range and on the assumption that the aggregate NPAs hived off from the books of the three banks would be of the order of Rs. 3,000 crore, the capital needed by the ARF would be in the region of Rs. 1,000 crore. Mode of payment 7.72 The payment in respect of the assets purchased from the weak banks may be made by the ARF by issuing special bonds for the purpose bearing a suitable rate of interest. It may also be guaranteed by the government in order to improve its liquidity. The bonds may, however, be issued to the weak bank with an initial lock-in period of at least two years so that its easy liquidity does not encourage the bank to enlarge its credit/investment portfolio aggressively even before the restructuring process has been completed and better credit and risk management processes have been firmly put in place. Maturity of bonds issued by ARF 7.73 The bonds issued by the ARF in payment of the assets acquired as also those which it will issue for raising funds against the security of assets it has purchased and which are in the course of collection may have a maturity of five years. A maturity shorter than this may not be practicable as recovery of loans on an average is likely to take some time. At the same time, maturities longer than five years may also not be desirable because if a loan cannot be recovered by the ARF in five years from the date of its purchase, the chances of its recovery are really not good. There would then be no point in continuing with the bond and servicing it for an indefinite period. Life span of the ARF 7.74 Not only the bond issued by the ARF but also the ARF should have a limited life. It should be able to complete its work, i.e., recover in full or part or sell the loans purchased by it within a period not exceeding seven years. It should not be envisaged that the ARF would buy NPAs from the banks on an ongoing basis and thus provide them with a ready avenue to dispose off their bad loans as and when these arise and the banks concerned choose to get them off their books. Such an arrangement would be a moral hazard because then the banks may not put in to their loan recovery efforts the kind of attention and diligence that is expected of them. They may also not pay due attention to acquiring and developing proper credit appraisal, monitoring and recovery skills. Recovery of its debt is a banks own responsibility and normally it must undertake this activity without hoping to pass it on to any other agency even if it is prepared to bear some cost on this account. The Working Group, therefore, is of the view that the ARF should purchase from the banks loans, which are NPAs as on a certain date, say, 31 March 2000. The responsibility of recovering loans, which become NPAs after that date should remain totally with the banks concerned. In view of the foregoing it will be adequate for the ARF to have a life not more than seven years from the

date of its commencing business, say, beginning April 2000. Cross country experiences also show that ARFs/AMCs are generally for a limited period, thus the RTC in the United States had a life of seven years, while in Sweden which initially gave a life of fifteen years to the AMC subsequently reduced it to five years on account of improvement in the market conditions. Banks to be covered by the ARF 7.75 In the first instance the ARF may buy NPAs only from the banks which have been identified as weak. To begin with, therefore, the ARF may buy NPAs of only the three identified weak banks, viz., Indian Bank, UCO Bank and United Bank of India. It would however not be desirable to preclude the ARF from buying loans from other banks, as this opening to the ARF for future need not be denied. Besides, there may be occasions when in the process of buying a particular loan from a weak bank in which the bank has been participating as a member of a consortium of banks, the ARF may find it desirable to buy out the shares of other members also in the consortium, which may not be weak banks. Furthermore, if the ARF is designed to accommodate NPA from other banks/ institutions this could increase the opportunity for more non-government participation in both ownership and funding. 7.76 The entity buying NPAs from banks has been conceived by the Group in the form of a fund as, under this format, it would be possible to set up more such funds later if need arises. Such subsequent funds could be area-specific, bank-specific, for a group of banks or for the entire sector. Participation in these funds may be open to both public and private sector. As a secondary market for loans develops in the country, such funds are expected to become common. Pricing of assets to be sold to ARF 7.77 The Technical Group, set up by the government to suggest an operating plan for ARCs, has recommended purchase of NPAs by an AMC in the private sector. It, therefore, had to take into account sensitivities attached to transfer of assets from public sector units to a private sector entity. For the same reason, it also considered it desirable for the bank selling the asset to set up a suitable floor price for disposal of the assets. While the Technical Group felt that a bank may not normally like to dispose of assets for less than 60 per cent of the latest value of the securities held plus five per cent of the unsecured portion of the loan, it did not prescribe any floor for pricing of assets. Its recommendation in this regard was that the banks may work out a suitable and detailed framework for deciding the floor price with the approval of the government and the Reserve Bank of India. It also recommended that transfer of any asset to the ARC should be well publicised indicating the amount due from the borrower and the securities held by the bank. 7.78 The aforementioned kind of sensitivity is not likely to arise in the structure suggested by the present Working Group since the ownership of the assets is proposed to be transferred to the government. In this context, it may also be mentioned that the guiding principle behind the structure suggested is that the asset acquisition by the ARF should not result in future losses for it. The price has to be, therefore, fair to both the buyer and the seller. The bank, however, while estimating a fair price for the assets to be transferred, must take into account the fact that it has so far not been able to recover the loan itself and that the time taken by the buyer to recover the loan would be indefinite. It would also be assuming the risk of recoveries being lower than the price paid.

7.79 The Group, therefore, noted that it would be difficult to prescribe rigid arrangements or a floor price for the transfer of NPAs and each case may have to be decided on merits taking into account the ultimate realisability of the assets realistically assessed on the basis of availability of securities, their present condition, the quality of documentation and the borrower himself. So long as pricing is arrived at by mutual agreement and in a transparent manner, the Group does not consider it necessary to prescribe either a floor price or a formula therefor. Asset Management Company 7.80 The management of the ARF would be entrusted to an independent Asset Management Company. The AMC, a private sector entity, will employ and avail of the services of top class professionals experienced in asset recovery such as qualified valuers, chartered accountants, lawyers, M&A and reconstruction experts and experienced bankers. The AMC can be compensated for the services it provides in the form of service commission on the value of assets managed coupled with some incentives for recoveries if these are higher than an agreed benchmark. Ownership of the Asset Management Company 7.81 In the ownership of the AMC, while the government would have a fair, may be even dominant, share up to 49 per cent, majority shareholding will be non-government. The other shareholders could be institutions like SBI, LIC, GIC, UTI and IFCI whose participation does not add to government shareholding and also parties from the private sector. The initial capital requirement of the AMC is not likely to be very high, say, not more than Rs. 15 crore and it would, therefore, not be difficult to attract non-government participants therein. It would also be possible to attract participation of multilateral agencies like IFC or ADB. The possibility of an existing fund manager in public or private sector offering to manage the ARF is also not ruled out. In fact, it may be desirable to explore this avenue. Staffing of AMC 7.82 The AMC, being the manager of the ARF, would need to have the capability of evaluating the loans to be purchased taking into consideration the collateral held therefor, relative documentation and the overall recoverability of the loan. It should also have the expertise to take necessary measures for due follow up of recoveries including legal action. It follows, therefore, that it must be manned adequately by professionals such as bankers, chartered accountants, engineers, lawyers and valuers. Being in the private sector, it might not find it difficult to meet these diverse requirements at market related remuneration. It should also be possible for the AMC to take people from the banks in order to have the benefit of familiarity with the assets acquired and possibly carried-on institutional memory. The overall structure of the AMC is, however, expected to be lean in order that it retains a desired level of cost efficiency. Impact of transfer of NPAs on the profitability of Indian Bank, UCO Bank and United Bank of India 7.83 To the extent that NPAs are taken off the books of the three banks and are moved on to the Asset Reconstruction Fund, the Fund would be paying them for the assets taken over by way of bonds bearing interest. This interest earning would add to the concerned banks income. The amount of NPAs to be taken over by the ARF will, therefore, be important for each of the three banks.

7.84 The Group is of the view that the principle of using the public sector banks median as the benchmark may be adopted in this case also. The gross NPAs of all public sector banks worked out to 15.89 per cent as on 31 March 1999. It would be desirable to assist the identified weak banks to reach a comparable benchmark of, say, 15 per cent. The table below gives the present level of NPAs and the reduction in terms of amount as well as a percentage of their total advances that will be required if they were to reach the aforesaid benchmark in respect of gross NPAs. Table 14: Percentage of NPA reduction proposed (Amount in Rs. crore) Name of the Bank Gross Advances Gross NPA Percentage of (3) to (2) 15% of Amount of Percentage (2) reduction of NPA desired reduction (3 5) desired 5 6 7 1,438 2,271 23.70 1,142 574 7.55 717 832 17.39

1 Indian Bank UCO Bank United Bank of India

2 9,584 7,610 4,782

3 3,709 1,716 1,549

4 38.70 22.55 32.39

7.85 The quantum of gross NPAs which would need to be reduced from the aggregate NPAs of the three banks has been shown in Table 14 above. It is recommended that the banks should generally transfer out of their books NPAs above a minimum value, say, Rs. 50 lakh. The details of such NPAs in the books of the three banks as on 31 March 1999 are given below:

Table 15: Details of NPAs and provisions (Rs. crore) Indian Bank NPAs above Rs. 50 lakh Provisions already held Net amount 1,979 1,067 912 UCO Bank 696 260 436 United Bank of India 661 421 240

While normally the banks may not transfer NPAs in the sub-standard category to the ARF, the decision in this regard will depend on the banks assessment about their recoverability. It may sometimes also become necessary to include substandard loans in order to make a given lot of NPAs acceptable to the ARF and secure as best a price as possible. These are, therefore, not being taken out of the ambit of NPAs that could be sold. 7.86 For the loans transferred to the ARF, the banks would require to be compensated by the ARF and for such losses as they incur on these transactions there will have to be added recapitalisation. In effect, one way or the other, the banks will get bonds equal to the book value of the loans transferred. On this basis, and on the assumption that such bonds will carry an average coupon rate of ten per cent per annum, the incomes of the three banks, viz., Indian Bank, UCO Bank and United Bank of India, can be expected to be augmented by Rs. 91 crore, Rs. 44 crore and Rs. 24 crore respectively. Following this cleaning up of their books, they will also not be required to make any further provisions on these loans and the requirement of capital adequacy will also be reduced correspondingly.

Reduction in cost of operations 7.87 The cost of operations of the three banks is highly disproportionate to their levels of earnings. Cost income ratio of the Indian Bank, UCO Bank and the United Bank of India for the year 1998-99 worked out to 141.22, 93.94 and 97.61 respectively showing clearly that the cost of their operations has reached unsustainable levels and that, unless the situation is corrected immediately, survival of the three banks could be in jeopardy. 7.88 The cost structure of public sector banks in India is such that more than 70 per cent is accounted for only by staff costs. A table showing the ratio of staff cost to total operating expenses in 1998-99 is given in Annex 12 which shows that ranging from 58.03 per cent and 60.94 per cent in the case of Oriental Bank of Commerce and Corporation Bank respectively, it rises to a high of 81.29 per cent in the case of UCO Bank and 82.57 per cent in the case of United Bank of India. Quite clearly, when it comes to cost management and reduction, nonstaff expenses are far less critical than staff expenses. Besides, these comprise of expenses incurred on items like rent and taxes, communication, printing and stationery and charges paid to professionals like lawyers, accountants and consultants. These are governed by market conditions over which banks have little or no control and, as long as the banks need for these services is irreducible, there is very little room for reduction in these expenses. 7.89 Management of costs then necessarily boils down to management of staff expenses which in the year 1998-99 accounted for 76.37 per cent and 80.60 per cent of the total operating income (NII + all other income) in UCO Bank and United Bank of India respectively. If the likely impact of wage revisions is taken into account, this ratio in their case might go past 85 per cent. In the case of Indian Bank, the position was much worse which, as it is, showed a figure of 107.79 per cent. Such high ratios of staff expenses to total operating income show clearly that the banks are having to spend most of their available resources to meet only the staff costs and that there is little left to spend on business- related improvements particularly for making changes in technology, which does not come cheap. This is because of considerable overstaffing in the three banks. When we look at not very differently placed public sector banks which while working under comparable conditions have this ratio generally below 45 per cent, it is easy to gauge the handicap banks with the same ratio at a level above 75 per cent, are facing. 7.90 A picture of the extent of overstaffing at the three banks also emerges when we look at the ratio of assets to employees. A statement showing this ratio for all public sector banks as on 31 March 1998 is at Annex 13. The position with regard to the three identified weak banks is also given below:

Table 16: Asset to employee ratio as on 31 March 1998 Indian Bank 19,454 9,440 13,514 4,040 26,994 2.06 1.44 4.82 UCO Bank 18,586 8,795 16,928 7,107 32,830 2.11 1.10 2.62 United Bank of India 14,389 5,855 11,076 5,110 22,041 2.46 1.30 2.82

Assets (Rs. crore) Officers Clerical Sub-staff Total employees Asset/Officers Asset/Clerical Asset/Sub-staff

Asset/Total employees @ 0.72 0.57 @ Median for all public sector banks excluding the three weak banks was 0.72.

0.65

7.91 The highest ratio of assets to employees in public sector banks in the year 1997-98 was that of Corporation Bank at 1.17. Oriental Bank of Commerce and Bank of Baroda followed with 1.04 and 1.00 respectively. While in public sector banks as a class the ratio of employees to assets is nearly seven times higher than in foreign banks, compared even to other public sector banks, the three banks are clearly overstaffed and are at a considerable disadvantage. 7.92 The balance sheets of the three banks will contract immediately after restructuring as substantial amounts of NPAs will move out of their books and the banks will also take steps to shed high cost liabilities. In the initial years after restructuring, the three banks will find it necessary to reduce intake of high cost liabilities until restructuring of the asset portfolio is complete and they have acquired skills and competitive abilities to deploy all the resources they can raise and build a sound and profitable advances portfolio. 7.93 It may be added in this context that while deciding whether or not there is overstaffing one should look at the issue not only from the angle of the total number of employees handling a certain quantum of business (asset/ employee ratio) but also from the angle of the banks operating income which gives it the ability to bear the relative costs. In fact, the latter consideration deserves a greater weightage as it provides an explanation why some banks which have a low assets to employee ratio or a high staff expenses to total income ratio are still able to record profits and appear to have better chances of survival. Their ability to generate higher net incomes and, therefore, a healthier cost to income ratio keeps them away from the disaster line. 7.94 The table contained in Annex 14 to the report shows how big a proportion of a banks overall income (all interest + non-interest income) goes towards meeting the staff cost alone. Banks which have to allocate a comparatively lower proportion of their overall income towards their staff costs have much greater flexibility and competitive advantage over others not so well placed in this regard. As competition intensifies, they can be expected to withstand falling margins and can also afford to incur expenditure for creating and supporting new businesses. 7.95 The Working Group has examined carefully the possibilities of the income of the three banks rising substantially in the near future and, for the reasons detailed in Chapter 6 of the report, is of the view that this is not feasible. There are clear portents that unless a significant restructuring as suggested herein takes place, high staff expenses will continue to keep their operating expenses close to or even in excess of their operating income. 7.96 The proportion of staff expenses to total operating costs in the three banks is quite high and indicates clearly that resources spent on employees are disproportionate to the banks current ability of earning. The ratios of staff costs to total income (including interest income and excluding interest income) of the three banks for the years 1997-98 and 1998-99 are given below: Table 17: Staff Cost to Total Income and to Operating Income

Indian Bank UCO Bank United Bank of India

Staff Cost to Total Income 1997-98 1998-99 23.48 23.40 27.07 25.74 22.67 22.26

Staff Cost to Operating Income 1997-98 1998-99 124.86 107.79 80.19 76.37 72.23 80.60

The table containing these ratios for all twenty-seven public sector banks is at Annex 14 and Annex 8 (G). It is noteworthy that the ratio of staff cost to operating income of these three banks are the highest in the industry. The median value of this ratio for 24 public sector banks (excluding the three weak banks) was only 46.58 viewed against which the ratios of these three banks indicate an unsustainable position. The three banks, therefore, have little choice but to take all possible measures to reduce their staff costs and bring it in line with at least the average performing public sector banks in terms of its percentage to total operating income (net interest income + non-interest income). 7.97 It needs to be kept in view that the three banks have not factored in the wage revision that is to become effective from November 1997. No provision in respect of the increase (12.25 per cent) has been made and should it become applicable to them not only will the yearly wage bill for the future years go up but substantial amounts will also go towards arrears for the period beginning from the date from which the revision becomes effective in their case. Further, these revisions have been made every five years which implies a possibility of yet another upward revision effective November 2002. With a possibility of yet another increase becoming applicable to the staff costs of the three banks only about three years down the line, the unsustainability of their current mode of operations becomes evident. 7.98 How can the three banks go about reducing their staff costs and bring it to a reasonable level vis--vis their income? Waiting for the income to go up or for the costs to come down as a result of natural attrition that will take place in the next four to five years is not a feasible solution because neither the growth in income is expected to outpace the growth in cost of staff at current levels nor is the likely natural rate of attrition in staff strength such that can make a real dent in the costs. The three banks are, therefore, faced with a Hobsons choice, a choice between sinking to unviability and reducing their expenditure on staff either by reducing the number of employees or by effecting a reduction in per employee cost. 7.99 The size of the reduction in the number of employees is an issue which has to be addressed very carefully. Considering the human angles involved, it must be kept to the minimum. At the same time, it has to be ensured that it does not end up as a token exercise with little or only a marginal reduction in costs failing to alleviate the pressure on viability in any significant manner. The objective will be served only if the reduction is of an order that will bring the staff cost ratios to at least the median level in public sector banks, a level without achieving which the three banks cannot expect to gain any competitive efficiency and a chance to survive as viable units. The table below gives the present number of their employees, the relative expenses, the resultant ratio of staff costs to total operating income, the median level of this ratio in public sector banks, and the estimated reduction in the staff costs which can be expected to improve this ratio in the three banks to the level of the median of public sector banks. Table 18: Required reduction in staff cost (Amount in Rs. crore)

Name of the Bank

Total staff cost

Indian Bank UCO Bank United Bank of India

427.00 483.96 340.84

Staff cost to total operating income (%) 107.79 76.37 80.60

Median for public sector banks (%) 46.58 46.58 46.58

Staff cost to total operating income at median level 184.52 295.18 196.98

Required reduction in cost to reach median level 242.48 188.78 143.86

7.100 The banks will also get some income on the bonds they receive as payment for their NPAs sold to the ARF as discussed in paragraph 7.86 above. This added income will help them meet some part of staff expenses and to that extent curtailment in staff strength can be avoided. The requirement of staff reduction would, therefore, get suitably modified. The following table shows the modified requirement of reduction. Table 19: Required reduction in staff costs after NPA transfer Name of the Bank Total staff cost (Amount in Rs. crore) Required Estimated Required Resultant reduction in positive financial reduction required cost to impact o/a of after adjusting reduction reach NPA transfer NPA transfer in staff median level (%) 242.48 91.00 151.48 35.5 188.78 44.00 144.78 29.9 143.86 24.00 119.86 35.2

Indian Bank UCO Bank United Bank of India

427.00 483.96 340.84

7.101 It may be mentioned in this context that a committee constituted by the Board of Directors of the UCO Bank has also identified a similar surplus in that bank. The other two banks do not appear to have made any such estimate formally. However, in the Groups view, the extent of reduction required is high and, considering the impact a sudden reduction of this magnitude will have on the operations of the bank, does not appear immediately feasible. Also, the net operating income of the bank is expected to grow every year even if not very substantially and would provide some further cushion for the staff expenses as long as the banks ensure that the present staff strength and the relative expenses remain capped. Considering all factors involved, the Group is of the view that initially a reduction in the staff strength of the order of 25 per cent may serve the purpose and should, therefore, be aimed at. It is expected that with the cost control and business improvement measures the banks are being asked to take up, there will be no need for any further precipitate reduction in staff strength and that natural attrition would take care of the reductions called for. If, however, the banks fail to increase their business and income base urgently, say, within the next two years even after the 25 per cent reduction, the picture will be quite different. 7.102 A 25 per cent reduction in staff strength would help the banks reduce staff costs correspondingly. This going by the expenses incurred in the year 1998-99, would work out approximately to Rs. 107 crore, Rs. 121 crore and Rs. 85 crore annually in the case of Indian Bank, UCO Bank and United Bank of India respectively. These amounts are substantial and, with the results of business restructuring flowing in, will provide the banks the necessary

leverage to attain the needed turnaround. 7.103 This step, although appearing to be drastic, is in the opinion of the Working Group, unavoidable. An effort to continue with the present strength for the next few years could jeopardise the survival of the three banks. The choice, therefore, is between reducing the staff strength now and protecting the banks future and not going in for the reduction and endangering its survival. In this connection, it may be mentioned that bank restructuring elsewhere too has necessitated drastic reduction in staff strength. Thus, for example, in Korea, the number of bank employees decreased by 34 per cent as of end-1998, compared to end-1997. The number of branches decreased by 17 per cent during the same period. China too has undertaken a similar exercise. 7.104 The Group is, therefore, of the opinion that in order to control their staff costs, the three weak banks will have to resort to a voluntary retirement scheme (VRS) covering at least 25 per cent of the staff strength. Recent experiences with VRS at some public sector organisations show that these schemes if structured properly and addressed to the staff with understanding can be quite successful. BHEL reportedly had to close their VRS within 24 days of its introduction when against the intended 5,000 applications, it received 7,000 applications. In the present situation of the three banks, such a scheme is expected to be seen by many as a good compromise and an acceptable exit avenue. 7.105 An exercise of this order is bound to be cost intensive and it is estimated that reasonable VRS for the three banks aimed at 25 per cent reduction would cost anywhere between Rs. 1,100 and Rs. 1,200 crore. At the first look, the amount appears high but as a permanent solution to one of the main problems faced by the three banks, it is unavoidable and, in the interests of restructuring the banks successfully, should be acceptable. 7.106 The Working Group recognises that the level of reduction in staff costs which is being suggested is the absolute minimum. It also needs to be mentioned that the rightsizing of staff will have to be achieved by the individual banks structuring their schemes in such a way that they are able to maintain the required balance between the different categories of staff and do not lose the desirable experience and skills they possess. While the Group does not propose to recommend the specifics of the VRS, the following main elements may need to be built therein care being taken, as far as practicable, to ensure that even after his/her voluntary retirement, the employee can lead a life of economic independence and dignity. a. The scheme will have to be voluntary but the right to accept or reject individual applications should rest with the management of the banks. b. The scheme should aim at separation of employees in the age group of 45 and above especially those in the 50-55 age group. c. The scheme should be in operation for a period not exceeding six months with discretion of early closure. The scheme must be implemented with care and compassion to guard against avoidable pain which is likely to accompany such separation. The banks introducing VRS should try and assist the separating employee in his/her post-retirement planning. While expert advice on the handling and proper investment of the amount of compensation under the scheme should be provided readily, the banks could also consider outsourcing select services from their employees availing of the VRS. Some banks are already availing of services of outside agencies in deposit mobilisation, follow-up and recovery of debts and conduct of different kinds of field surveys. These and similar other activities can be outsourced through properly organised groups of employees going out under the VRS. Banks may consider assisting the

employees in forming suitable organisations for the purpose. 7.107 Alongside operating Voluntary Retirement Schemes, the three banks will also need to undertake considerable retraining and relocation of the post-VRS staff strength. The banks will have to ensure changes in the job content and skills of the different categories of employees so that their services can be put to best use at points where these will be needed most in accordance with the changed operating strategies of the banks concerned. Such reskilling and relocation should be made a precondition for future recapitalisations. Capping staff costs 7.108 In order that the VRS and the needed reduction in staff costs have a real impact on the operating results of the banks concerned, it would also be necessary to place a cap on the staff expenses of the three banks. Towards this, the Working Group recommends that a freeze on all future wage increase including the one presently under contemplation, i.e., with effect from November 1997 be put in place. This may continue for a period of five years. 7.109 It should also be understood in this context that the main objective behind the introduction of VRS in the three banks being a sizeable reduction in their operating costs, the scheme would need to be successful within a reasonable period. This cannot be allowed to become one of those schemes which are introduced but in effect remain dormant. If VRS does not lead to the needed reduction in the banks operating costs, there will be no alternative left but to resort to an across-the-board wage cut of an order which will result in a similar reduction in costs. It is with this urgency in mind that the Working Group has suggested keeping the VRS open for a limited period of six months. 7.110 To the employees of the three banks, these suggestions are bound to appear precipitate and harsh. It may be argued that they are being unfairly singled out and are having to pay for what is not their doing. To a certain extent, it may appear to be so but at this point of time, none of the parties involved, viz., the government, the bank or the employees are left with any choice. Wherever the fault may lie, the fact of the matter is that the banks are unable to earn the kind of income which is required for sustaining their present staff expenses. The only other source of sustenance in these cases is recapitalisation support from the government but this too is not readily available because of the increasing pressures and other compelling demands on the governments resources. If, therefore, the banks are to survive, most efforts and sacrifices will have to be their own. Outside support can only be limited and will be predicated upon what the three banks can do themselves. Estimated cost of operational and financial restructuring 7.111 The overall cost of restructuring the three banks over the next three years is estimated by the Working Group to be of the order of Rs. 5,500 crore. A purpose-wise breakup of the required amount is given below. a. Technology upgradation @ Rs. 300-400 crore b. VRS @ Rs. 1,100-1,200 crore c. NPA buyout Rs. 1,000 crore d. For capital adequacy Rs. 3,000 crore @ Funds for (a) and (b) will have to be provided in cash.

Out of the Rs. 3,000 crore required for capital adequacy, approximately Rs. 968 crore is the

immediate requirement of the Indian Bank to achieve the needed CAR of nine per cent. In the next three years, additional requirements of the three banks for CAR are estimated to be in the region of Rs. 2,000 crore. 7.112 The above estimates are based on the projection of the concerned banks operations in the next three years ending March 2003 which in turn have been based upon their present operations and likely changes/improvements therein in the course of their restructuring. It has also been assumed that the restructuring programme will begin no later than April 2000 and the necessary additional recapitalisation and other supports by way of NPA takeout and technology upgradation will be completed within a timebound schedule. The estimate could turn out to be inadequate if some hidden surprises surface or some delays or other roadblocks are encountered in the course of implementing the programme. However, the final figure is not likely to be very far out of the estimate presented above. Organisational Restructuring Administrative structure 7.113 Most of the public sector banks, because of the rapid pace of the expansion of their branch network and the vast geographical area that is covered by them, have a fairly complex administrative structure. The report of the CBSR also has pointed out that, as a result of expansion and the complex administrative structure, the efficiency of the three banks has suffered. It was pointed out by the CBSR that lines of command and control have lengthened to the point of weakening of central office supervision without effectively decentralising decision making and operations. This continues to be a limitation with all public sector banks and in the weaker banks it is proving to be even more worrisome. In the three banks, the decision making process has been totally impaired and while it is multilayered, each of these layers is delay laden and without any clarity of policies and purpose. 7.114 At some banks, some attempts at organisational restructuring have been made in the recent past, UCO Bank being one of them. The Group, which had an occasion to study UCO Banks working, did not however notice any marked improvement in or shortening of the decision making process. Although there is reportedly some delayering in the process, the administrative structure continues to be diffused. It may be added in this context that delayering alone would not speed up decision making unless other essential preconditions like clearly laid out policies and procedures, skills and adequate discretionary powers are available at the different levels of decision making. The management of the concerned banks and their respective Boards would need to pay urgent attention to this issue without which loss of business will be very difficult to arrest. Branch network 7.115 Another important organisational issue concerning the weak banks is the spread of their branches. Indian Bank, UCO Bank and United Bank of India have 1492, 1790 and 1333 branches respectively with an average per branch business (advances + deposits) level of Rs. 14.67 crore, Rs. 10.08 crore and Rs. 12.69 crore respectively during the year 1998-99. The corresponding figure for public sector banks works out to Rs. 17.28 crore. It would, therefore, appear that the three banks have a larger network of branches than what their level of business calls for. Besides the sustainability of this large a branch network with their current levels of business, there is the question of concentration of branches in specific areas with which United Bank of India and UCO Bank are faced. At a fairly large number of centres,

branches of the same bank are only eating into each others potential of business without contributing by their presence in any significant manner to the total potential of business available for the bank. There is, therefore, an urgent need to consider rationalisation of branches in all the three weak banks. Such rationalisation is also expected to help the three banks in much needed cost reduction. It is understood that UCO Bank has already embarked upon such a plan. It is time that the other two banks as well think on these lines. 7.116 An area-wise analysis of the per branch business of the three banks as compared to other banks is given in Table 20. It may be seen that under all the categories, i.e., rural, semiurban, urban and metropolitan, the branches of the Indian Bank, UCO Bank and United Bank of India have, on an average, lower per branch business levels as compared to the branches of nationalised banks. While in the case of the UCO Bank, the difference between the average business levels at their branches and the branches of the nationalised banks is quite sizeable, going up to over 40 per cent, in the other two banks also the business level of their branches is lower by about 25 to 30 per cent. The high NPA level at most of these branches aggravates the problem further. Many of these branches are, therefore, for obvious reasons making losses and are not likely to become profitable in the foreseeable future. Table 20: Area-wise business of Public Sector Banks as on 31 March 1999 (Rs. crore) State Nationalised Public Indian UCO United Bank Banks Sector Bank Bank Bank of Group Banks India Rural Deposit 23,794 55,512 79,307 1,537 3,136 2,807 Credit 10,012 21,176 31,188 765 908 727 Total business 33,806 76,688 1,10,494 2,302 4,044 3,534 Branches 5,509 13,922 19,431 538 892 671 Business per branch 6.14 5.51 5.69 4.28 4.53 5.27 Semi-urban Deposit 48,668 68,141 1,16,809 3,092 2,476 2,477 Credit 18,740 21,570 40,309 967 611 471 Total business 67,408 89,711 1,57,118 4,058 3,087 2,948 Branches 3,926 6,714 10,640 376 278 202 Business per branch 17.17 13.36 14.77 10.79 11.10 14.59 Urban/Metropolitan Deposit 99,320 2,61,046 3,60,366 11,213 8,480 8,581 Credit 85,679 1,46,235 2,31,914 6,010 4,322 3,571 Total business 184,999 4,07,281 5,92,280 17,223 12,802 12,152 Branches 3,855 11,672 15,527 581 620 460 Business per branch 47.99 34.89 38.15 29.64 20.65 26.42 All India Deposit 1,71,782 3,84,699 5,56,482 15,842 14,092 13,865 Credit 1,14,430 1,88,980 3,03,411 7,741 5,841 4,768 Total business 2,86,213 5,73,680 8,59,892 23,583 19,933 18,634 Branches 13,290 32,308 45,598 1,495 1,790 1,333 Business per branch 21.54 17.76 18.86 15.77 11.14 13.98 7.117 It may be added in this context that most public sector banks are not following a scientifically developed objective transfer pricing system between their branches and branches and the administrative offices. In some cases, the transfer pricing policy has often

been modified to suit a particular type/group of branches so that the number of loss making branches could be brought down. Such an effort is really pointless. It does not change the overall profitability of the bank. Nonetheless, some banks seem to prefer the approach, at least, to be able to show that the number of their loss making branches is not very high. In the circumstances, the Group, after due consideration, has come to the conclusion that branches of these banks which are more than five years old but at which business levels are still less than 50 per cent of the average per branch business levels in the same category of branches in the nationalised banks should be merged with another branch of the bank. Merger with a nearby branch of another nationalised bank can also be considered. Such branches are clearly unviable and little purpose would be served by continuing to incur costs thereon. Having not achieved even 50 per cent of the average business level of branches in the same category of all nationalised banks, most of these non-performing branches are unlikely to improve their business prospects and will continue to be a drag on the weak banks profitability. 7.118 The weak banks must, therefore, take a hard and careful look at each one of these branches and after convincing themselves about their unviability decide to discontinue these operations. By continuing such operations, hoping that these will improve in future or by showing them artificially as profitable using a transfer pricing mechanism which favours them unduly, the problem will be compounded and elude solution even in future. It therefore stands to reason that the banks merge two or more unviable operations into one viable operation. As long as the banking requirement of the clientele and the area served by the unviable branch can be met by another branch of that bank or any other bank, in the immediate interest of the weak banks and long term interests of the Indian banking system unviable branches should be closed. Top Management 7.119 The working of the top management in weak banks is seen to be constrained by both internal as well as external factors due to which it has not been able to respond to the stiff challenges faced. Absence of dynamic leadership for long periods has been a major contributory factor to the consistent deterioration in the functioning of these banks. Considering the future changes and challenges that are likely to be faced by the banking sector in general and the weak banks in particular, the Working Group is convinced of the need for appointment of CMDs who are especially suited to their jobs. The concept of differentiating between war-time generals and peace-time generals holds good here as well and the Group is of the considered view that the CMD in a weak bank has to be in the nature of a war-time general possessing special skills and attitude helpful in restructuring of an organisation. Incumbents in these positions need to be proven achievers who can lead from the front. 7.120 It is equally important that the CMDs of these banks have a sufficiently long tenure, say, a minimum of four to five years for effectively discharging the complicated task of restructuring a bank and should evidently be in the age group of 50-52 years. In order to ensure uninterrupted progress of the restructuring plan and to commit the top management thereto fully, this tenure may not be ordinarily curtailed. 7.121 The Group has also received suggestions and agrees with them that the right persons for these jobs should be provided with incentives, both monetary and non-monetary, for achieving the restructuring mission successfully even if giving such incentives means making a departure from the existing norms. In such cases, a higher package of remuneration and special performance bonuses made payable on achievement of specified performance targets built into the restructuring plan are worth serious consideration.

7.122 There could be other ways as well for providing incentives for talented and ambitious persons to take up the arduous task of restructuring weak banks. If in the four or five year career of a person as CMD of a weak bank the bank shows a definite improvement, he could be considered for heading one of the prime banks/financial institutions in the country. It would not be necessary to make this kind of provision a part of the contract, but in exemplary cases, the point could be well made by setting precedents. Such a step would go a long way in removing the kind of hesitation or even stigma that is felt by people working in the weak banks and would motivate them to face the special challenges before them with greater willingness, determination and belief in the future. It must however be added in this context that the best incentive would still be financial and a way would need to be found to remunerate the CMDs and EDs of banks undergoing restructuring for regaining their competitive efficiency. 7.123 Presently, public sector banks have only one position of Executive Director. Also, experience shows that an Executive Director seldom succeeds the outgoing CMD in the same bank. The Group found that this arrangement creates a sense of non-involvement in the banks affairs on the part of the ED. The CMD, on the other hand, develops a feeling of isolation and finds it difficult to build a team. A distance between the top two functionaries of a bank always works to the detriment of the organisation. The Group, therefore, feels that in at least the weak banks, a line of succession should be developed well in time and a system put in place whereby, save exceptions, an ED should succeed the outgoing CMD. The Group also feels that excepting in very small banks, there should be two EDs. This should be more so in weak banks where a very senior functionary, besides the CMD, should be charged with the responsibility of driving the restructuring process leaving the CMD free to pursue other strategic growth issues. Board of Directors 7.124 The role of an active board in planning comprehensive strategies to steer past the various hurdles is critical in weak banks. The boards of these banks need to be reconstituted to include eminent professionals, industrialists and financial experts with the necessary training, experience and background to provide strategic support to the CMDs team. Based on the experience of working of these boards, there is a general view that the present constitution of the banks boards admits a review, especially in the weak banks where the board has a special role to play in guiding the banks out of trouble. The Working Group is in agreement with this view. In these cases board level support to the banks management in strategising, decision making, target monitoring and course corrections have to be regular and extensive and the board needs to possess not only the talent and will but also a cohesive and focused approach to do it. It is important for the weak banks that their boards function as totally cohesive bodies. 7.125 In this context, the Working Group is of the view that the presence of government directors has been more of a disadvantage in the working of the boards of public sector banks. Because of their position in the government and more specifically because the governments role as the owner of these banks gets stressed in one way or the other, government directors domination in the proceedings of the boards becomes almost automatic. In most cases, the other members of the board look for a signal from the government director and for one reason or the other chose to follow the line adopted by him. On occasions, when the government director is not able to attend the board meetings, important decisions tend to be postponed. In the interest of proper working of the board of banks and more so in the interest of the boards assuming at least some degree of

responsibility for adding shareholder value and being accountable for their decisions, Government of India needs to consider withdrawing its functionaries from the banks boards. There should be a clear distinction between the two roles, the one relating to ownership, which the government has, and the other relating to management, which it does not. It may be argued that the government functionary is only watching in the board the interests of the majority/sole shareholder. But, if such a watch impinges upon independent thinking and working of the boards, it becomes counterproductive and runs against the governments own long term interests. As a first step in the direction, therefore, the government may consider withdrawing from the banks boards its own serving officers and replace them with independent nominees having relevant knowledge and background in the area of operation of the unit concerned. Such nominees will not have the force and authority of any position in the government and would then be treated by the members of the board as their equal. Human resources 7.126 There is apparently room for staff restructuring in the three banks. It is possible to take a view that with increase in business and earnings, this position could improve. However, an analysis of the situation undertaken by the Group has shown that there will be important preconditions to fulfil before the three banks can expect to register any sizeable increase in their earnings. 7.127 The leadership at the middle levels in the three banks is seriously lacking. This is largely because of inadequacies in skills both in traditional areas of banks operations as well as the new areas in which most banks are now moving. In specialised areas like credit, treasury operations, foreign exchange and, of course, IT, the three banks are extremely deficient in skills and are almost out of the market. A bank like the United Bank of India, with nearly 1,300 branches, has an income level of only about Rs. 8 crore per annum from foreign exchange business. Similarly, any of these three banks has hardly any treasury product to offer to its clients and so far as information technology is concerned, it has hardly been introduced. 7.128 The banks quite clearly need considerable assistance in these regards and while a longer term training and reskilling programme will have to be undertaken by them, they would also need to resort to some recruitment in the senior and middle levels of management from the market. Provision would need to be created for such recruitment by them. Without such recruitment and lateral movement of talent, the three banks will find it extremely difficult and time consuming to develop the much needed skills for entering and operating in the emerging areas of banking business. 7.129 As has been mentioned earlier, the training facilities available in the three banks are inadequate to meet the needs that would now arise following the restructuring efforts. These will, therefore, have to be considerably strengthened. It is also worth considering whether training facilities created by more than one bank should be pooled for better utilisation of the facilities created and optimum utilisation of the limited training skills available. This would also lead to improved consistency and quality of training. The Group has suggested earmarking a part of the capital support for HR activities including VRS. A sub-allocation out of this earmarked capital support may be made for re-skilling and training. Financial restructuring 7.130 Financial restructuring has to be undertaken to ensure the solvency of the three banks. Reserve Bank of Indias regulatory norms require banks to maintain a CAR of eight per cent.

This is being increased to nine per cent with effect from the current year ending 31 March 2000. In the past, the Government of India has had to bring in Rs. 20,446 crore to provide as capital to the nationalised banks so that they could meet the prescribed CAR norms. Out of this, capital infusion in the three identified weak banks has accounted for Rs. 6,740 crore. Individually, their share till 31 March 1999 was as under: Table 21: Aggregate capital provided, accumulated losses and CAR Indian Bank 1998 1999 2,575.90 2,675.90 2,403.38 1.41 3,181.88 (-) 8.94 UCO Bank United Bank of India 1998 1999 1998 1999 2,056.52 2,256.52 1,708.06 1,808.06 1,736.00 9.07 1,803.90 9.63 1,424.45 8.41 1,409.75 9.60

1. Aggregate capital (Rs. crore) 2. Accumulated losses (Rs. crore) 3. CAR

7.131 With the above capital infusion while UCO Bank and United Bank of India were able to meet the minimum CAR requirements, Indian Banks requirement of capital being much higher, it failed to meet the prescribed norms at the end of the financial year 1997-98 as well as 1998-99. This is, as shown above even after the massive capital infusion to the extent of Rs. 6,740 crore already received by them. It has, in effect, been operating for the whole of 1998- 99 without meeting the regulatory requirement of minimum capital adequacy.Further capital infusion in its case is, therefore, imperative to ensure that it continues business operations normally. 7.132 Although due to its government ownership, and largely due to lack of understanding of these issues on the part of the average depositor, the deposit taking activity of the Indian Bank does not appear to have suffered so far, this situation cannot be expected to last too long. In future, if the banks capital adequacy is not corrected even its deposit taking ability may suffer. 7.133 An effort has been made in paragraph 7.111 to give a break up of these requirements purpose-wise. In this context, it needs to be mentioned that the banks, in order to be able to attract good business, will need capital in excess of the minimum required. With minimum permissible level of capital adequacy, they can hardly scout for and expect to book additional business which will necessitate their having more capital. Experience has shown that once a banks CAR is close to the minimum, it starts shunning new business. Good and larger clients also begin looking elsewhere as they know that the bank is no more in a position to meet their additional requirements of credit. 7.134 Marginal CAR also affects the asset portfolio of a bank as in this situation it will prefer to book assets which bear zero or very low risk weights and do not attract requirement of capital. The asset build up of the bank, then, shows heavy preference towards government papers which, though bearing zero risk weight, have much lower yields as compared to its own advances portfolio. This will obviously affect its earnings. 7.135 For maintaining a good loan book as also a balanced overall asset profile, banks need to maintain at all time CAR at a level comfortably above the minimum required. The Working Group is, therefore, of the view that at financial restructuring of a bank should aim at raising its CAR to at least one per cent above the minimum required so that it can continue with its credit business normally.

7.136 So far, the government has used recapitalisation bonds as the instrument for recapitalisation of banks. While some of the initial issues bore a coupon rate of 7.75 per cent per annum, subsequent issues were with a 10 per cent coupon. The Group is of the view that to the extent immediate cash funds are not being made available to the banks, this mode of capitalisation may be continued. 7.137 In the restructuring plan for the weak banks, which is proposed by the Working Group, a portion of the additional capital requirement would need to be provided in cash. The question of its servicing also needs to be considered very carefully. So far, they have not had any motivation to service the capital provided to them. This, as pointed out earlier, has acted as a serious moral hazard and has affected their performance. The Group, therefore, feels that as a measure of introducing some accountability for using additional funds, the weak banks must undertake to provide a return. At least, on such portion of capital funds, which are provided in cash/by transfer of funds, there needs to be an arrangement, even if deferred, for payment of interest. The government may decide to bring in such capital by way of preference capital or subordinated debt forming a part of Tier II capital of banks on which the recipient banks may be required to pay interest. 7.138 One of the most important reasons for the weak banks not succeeding in improving their performance has been the unconditional recapitalisation support received by them so far. The bank management and the staff have always felt confident that, whatever be the banks performance, its need for additional capital to keep it afloat will always be forthcoming from the government. There has been, therefore, very limited effort to build good business, increase earnings and to reduce cost. Memoranda of Understanding entered into with the Reserve Bank of India and even the Strategic Revival Plans, which were prepared by the banks themselves at the instance of the Government of India, have failed to serve the purpose. Year after year, the three banks have failed to meet most targets and undertakings contained in these documents. 7.139 Considering the banks past performance, the Working Group has come to the conclusion that any further recapitalisation of weak banks must be accompanied by strict conditionalities relating to operating as well as managerial aspects of the recipient banks working. There should also be conditionalities about the manner in which these funds can be deployed and about their servicing. The banks concerned need to recognise that they have an obligation to service the capital and that therefore their demand from the government for additional capital without any limit is just not sustainable. 7.140 In the assessment of the Group, the weak banks will be needing additional capital to meet the following requirements: a. moving some portion of the NPAs out of the books, b. cost of modernisation of technology, c. HRD related costs including that of VRS, relocation, training and skill building exercises that would have to be followed in the course of restructuring, d. capital adequacy.

Funds required for items under (b) and (c) will have to come by way of cash and cannot be provided in the form of bonds as has been done so far. Requirements for items under (a) and (d), however, can be met through bonds as hitherto. 7.141 The Group is of the opinion that future capital infusions in weak banks should be clearly earmarked for specific purposes indicating the amount that could be used under the head as also the period within which it could be utilised. For the portion of capital infusion, which will be by way of actual transfer of funds, the arrangement should be such that the funds become available only when the banks undertake the specific activities for which these have been earmarked. An account with the government or with the RBI could be opened from which earmarked funds could be made available. As indicated in paragraph 7.137 above, for the present, this arrangement would extend to modernisation of technology and specified HR related expenses. 7.142 The concept of payment of interest on capital funds that may now be provided in cash/transfer of funds, is sought to be introduced not so much because the government must get a return on the funds provided but mainly because the recipient banks management should factor in this obligation in the cost of their operations. Some of these banks have been expressing intention of accessing capital markets for long term debts to serve as part of their Tier II capital. If they are successful in their efforts and raise the funds, they will no doubt have to service such debts at a high cost. If, therefore, they were to receive funds from the government, there is no reason why these must be cost-free. However, considering their present financial condition, the government may decide to give them moratorium on payment of interest for one or two years, i.e., until the deployment of these funds starts getting reflected in their operating results. The agreed rate of dividend on such preference shares and interest on subordinated debt may not be market-related and kept low. It may even be so structured that, in the initial years, the rates may be lower, rising only after the banks earnings are expected to grow. The point that needs to be made is only that there must be an obligation on the part of the bank using the funds to recognise these as cost bearing. 7.143 In paragraph 7.136 above, the need for any further capitalisation being accompanied by strict conditionalities has been stressed. In the foregoing paragraphs, some of those conditionalities have been suggested. In general, it is also felt that all future recapitalisation should be under an agreement, between the government on the one side and the banks Board of Directors, its management and staff and employee unions on the other, laying out the restructuring goals. The agreement, while stating clearly the extent of governments involvement and the responsibilities of the bank, should also contain details of the banks obligations to perform and report, precise milestones for performance and measures that will follow non-performance, treatment of NPAs and near term improvements in operating results. It would also be desirable to assign selected financial indices for the bank to follow within a timeframe. The performance under this agreement will have to be monitored closely. The Groups recommendations regarding the agency, which could be entrusted with this kind of follow-up, are contained in detail in paragraphs 7.143 to 7.147. Systemic Restructuring Setting up of a Financial Restructuring Authority (FRA) 7.144 Based on past experiences of implementing bank restructuring programmes in

different countries across the world, it is considered necessary that an independent agency be entrusted with the responsibility of monitoring the progress of any such programme being put in place. The role and importance of an independent agency in driving a restructuring programme and monitoring its progress constantly has been discussed earlier in paragraph 7.4 (e) of this report. 7.145 In most cases where bank restructuring programmes have been undertaken, setting up of such an agency has been found essential. In Korea, this issue was addressed by setting up a new bank supervisory body, i.e., the Financial Supervisory Commission (FSC). While taking over the regulation of financial institutions from the Ministry of Finance and Economy (MOFE) and the Office of Bank Supervision (OBS) of the Bank of Korea, the FSC also undertook the responsibility of conducting the programme of bank restructuring. For achieving this objective, it established the Financial Restructuring Unit to oversee and coordinate the financial restructuring. In Thailand, the programme has been handled by setting up of the Financial Sector Restructuring Authority (FSRA) by the Ministry of Finance. The role assigned to FSRA in Thailand was to assume control of and liquidate the suspended finance companies. In Indonesia, restructuring is managed by a special agency set up for the purpose, i.e., Indonesian Bank Restructuring Agency (IBRA) which is a division of the Ministry of Finance. It has been given the responsibility of resolving non-performing loans. An Asset Management Kredit (AMK) has been set up within IBRA to receive bank assets including NPAs. Even in one of the earlier restructuring programmes undertaken in Sweden in the early 1990s, a separate restructuring agency known as the Bank Support Authority (BSA) was set up. It has thus been a common feature across the countries attempting restructuring of banks/financial institutions to set up a special agency which runs the restructuring programme monitoring its progress bank-wise while the banks themselves implement their respective plans. Obviously, existence of such an agency facilitates coordination between the different entities which are being restructured as also between the owners, the government and the regulatory authorities. 7.146 The Working Group is of the view that in order to ensure success in restructuring of weak banks, the Government of India should also consider setting up of a similar body. This may be called the Financial Restructuring Authority (FRA). Its main objective would be to co-ordinate and monitor the progress of the programme. It will represent the owner, in this case the Government of India and, vested with due authority from the government, it would be able to give the banks undergoing restructuring, guidance and instructions for proper implementation of the programme including course corrections wherever necessary. This authority will have to work in close co-ordination with the Banking Division, Ministry of Finance, which presently controls the public sector banks. While the basic control of banks covered by the restructuring will continue to be with the Ministry and there will be no change in the Reserve Bank of Indias role of regulation and supervision, the FRA will monitor the progress of the programme and will have the powers to take all decisions relating thereto which the owner needs to take. In this regard, it will be an arm of the government. Its role and functions would need to extend over the policy as well as operational aspects of the restructuring programme and may include, inter alia, the following. i. approving bank specific restructuring programmes, ii. entering into agreements with individual banks covering the terms and conditions of the programmes and following up its progress with the bank and other concerned agencies. The need for such an agreement has been discussed in paragraphs 7.26 and 7.140

above, iii. acting as an owner of the Asset Reconstruction Fund on behalf of the government and ensuring its proper governance, iv. owning and/or participating in other Asset Reconstruction Funds/ Asset Reconstruction Companies that may be set up subsequently, and v. arranging for the management of these funds by appointing Asset Management Companies. The structure of the proposed NPA transfer mechanism, presented in a chart form, is given in Annex 15. 7.147 The Group is of the view that it would be desirable to set up such an authority under an Act of the Parliament so that with the force of law behind it the FRA enjoys a distinct individuality. Such force and distinction are considered necessary for any entity that will perform the kind of tasks it will be entrusted with. 7.148 The existing legal and institutional framework is defaulter-friendly and has been one of the biggest hindrances in recovering loans. In the absence of a special enactment for the FRA as proposed above, it will find it very difficult to succeed because the loans transferred to its ARF will mostly be chronic non- performing loans where the banks efforts have already failed. The borrower having succeeded in frustrating the recovery efforts of the bank will be emboldened to continue frustrating the FRA as well. Conditions, therefore, need to be created so that borrowers do not find it advantageous anymore to frustrate the ARFs efforts at recovering its dues. 7.149 There have been earlier occasions when, by specific enactment, special powers/rights for recovering loans and/or dealing with collaterals relating thereto have been given, e.g., in the case of State Financial Corporations and the erstwhile Industrial Reconstruction Bank of India now operating as the Industrial Investment Bank of India (IIBI). Adopting a similar approach in the case of FRA, it may be established under a special Act of the Parliament with provisions protecting it against avoidable obstructive litigation and also from the necessity of legal procedures in enforcement of mortgages and other contractual rights. 7.150 The FRA is not being conceived as a permanent body as it is expected that, with the completion of the restructuring process of the weak banks, it would have outlived the utility of its existence and would be wound up with the winding up of the ARF it will own. Its existence may, however, have to be continued if in the meantime, some other bank or banks become weak and their restructuring is entrusted to its care. Regulation and supervision of weak banks 7.151 Regulation and supervision of all banks is at present with Reserve Bank of India and receives the same kind of attention as received by all other banks. In view of the special problems faced by these banks and in order to ensure that their condition receives a more urgent and focused attention of the regulator, it is considered desirable that special arrangements be made for tracking their performance and regulatory compliance. The success of the FRA in carrying through the restructuring programme would depend largely on the quality and level of coordination it is able to achieve with the regulator on the one hand and the government on the other. It will, therefore, facilitate the process substantially and help effective implementation of the restructuring programme if within Reserve Bank of India, a

special wing is formed for regulating and supervising weak banks. On a number of issues like deposit insurance, regulation of subsidiaries, risk management, disclosures and regulatory compliance, the treatment of weak banks would need to be different from those of much stronger normal banks. A more focused regulation and supervision will facilitate weak banks early restoration to health. This arrangement would also help early detection of and attention towards weaknesses emerging in other banks preempting a system-wide spread of these problems. Improvement in the legal framework 7.152 The legal framework within which banks have to operate and particularly manage the recovery of their dues from the borrowers is far from adequate. For understandable reasons, many legal provisions have, in fact, a positive bias favouring the debtor who has traditionally been seen as weak and, therefore, in need of protection. Unfortunately, these very well intentioned provisions and the immense load and backlog of cases with the courts are making lending a hazardous option for the banks. Prolonged litigation prompted by legal lacunae in different commercial enactments is one of the main reasons for the increase in the size of the banks NPAs. Some of these enactments are several decades old and, in quite a few cases, out of line with the present day realities. These provisions need to be amended urgently and some new enactments are called for in order to cater to the requirements of the changed and far more complex current economic and business environment. 7.153 Financial systems in other Asian countries too have suffered from similar handicaps. Many of them, however, have changed/amended their outdated and inadequate laws as part of the countrys financial system restructuring. Thus, for example, within a short span Thailand has achieved an almost total revamp of laws relating to commercial transactions. Bankruptcy law has been modelled along the lines of provisions contained in various chapters of Title 11 of the U.S. Code in the United States and further changes therein are being enacted. Changes to laws on foreclosure and court procedures are also being enacted to ensure speedier enforcement of lenders claims. Specialised bankruptcy courts are also being set up. These are necessary for any exercise aimed at facilitating recovery of banks dues and reduction of their NPAs. Similarly, effective changes in the legal framework in Malaysia have been made preventing the borrowers from making use of the legal process to delay creditors action against them. It is noteworthy that special steps have been taken there to plug loopholes that previously allowed borrowers to contract additional debts or dispose of their assets while restructuring schemes were being worked out. 7.154 It would be necessary that changes along similar lines are made in our laws so that it can be ensured that the banks are not handicapped in their efforts of recovering dues from the borrowers. It is also important to note that without proper legal backing, the ARF also will suffer similar handicaps. Above everything else, it would be impossible to develop a secondary market in loans unless the necessary legal provisions facilitating hassle-free transfer of loans and recovery of dues are in place. The working of Debt Recovery Tribunals 7.155 With a view to expediting recovery of dues through the legal process, Debt Recovery Tribunals (DRT) have been established under the Recovery of Debts Due to Banks and Financial Institutions Act, 1993. However, for many reasons, the DRTs have so far helped the recovery process of the banks only in a limited manner. The Group is aware that measures for strengthening DRTs have been examined by the Reserve Bank of India in the light of the

recommendations made by CBSR. The recommendations made in August 1998 by a Working Group set up in this regard address structural aspects of the functioning of DRT as well as the legal lacunae observed in the Act. The present Group understands that, in the light thereof, a Bill to amend the above Act has been introduced in the Parliament. 7.156 The Group also understands that the entire legal framework for effecting recovery of bank dues is being examined by an expert Group constituted by the Government of India under the chairmanship of Shri T. R. Andhyarujina, former Solicitor General of India. The expert group would also address the lacunae observed in the functioning of the DRTs and suggest amendments required therein. The present Working Group is of the view that till the necessary amendments to the Recovery of Debts Due to Banks and Financial Institutions Act, 1993, are made, steps should be taken to remove the administrative and infrastructural problems relating to the DRTs to improve and facilitate their effective functioning. The Group also considers it desirable that insofar as the recovery process of weak banks and the ARF is concerned, an arrangement may be worked out for the DRTs to attend to their cases on a priority basis. Towards this end, at least at some select centres, setting up of special benches of DRTs to assist weak banks and the ARF could be considered to give the restructuring process the much desired push. Issues relating to vigilance 7.157 In the course of its deliberations, the Group received representations from the managements and the unions of the banks alike complaining of a sense of diffidence in taking credit decisions with which the banks are beset at present. Reportedly, this is due to investigations by outside agencies on the accountability of staff in respect of some of the NPAs. The Group also noticed a marked reluctance at various levels to take any credit decision. It has already been referred in an earlier chapter, how decisions are being deferred on compromise proposals in respect of NPAs. The banks, consequently, carry a heavy load of provisioning requirements and other attendant losses which they can ill afford. The Group is concerned that restructuring strategies which of necessity assume certain minimum levels of growth would not succeed if such a mindset persists. 7.158 The Group notes the recent initiatives taken by the CVC to include in the Vigilance Manual a separate chapter relating to vigilance in banks. Provisions contained therein address some long-standing concerns of the banks. In this context, the Group would like to recommend that the investigations into accountability both at the bank and at the level of non-bank agencies if completed in a time bound manner would go a long way in ending uncertainties and help in the overall improvement of morale of the staff. A time bound approach in these matters is absolutely necessary for creating appropriate conditions in banks in general and in weak banks in particular for future business growth and turnaround within a short timeframe. Concluding remarks 7.159 Indian Bank, UCO Bank and United Bank of India, although weak are, in the opinion of the Working Group, still revivable if urgent steps are taken to initiate and implement a comprehensive operational, organisational and financial restructuring programme, provided it receives consensual support of all the stakeholders. The cost of restructuring, estimated at about Rs. 5,500 crore, to be incurred over the next three years, though high is considered the unavoidable minimum and, therefore, acceptable. Nearly two-thirds of this amount, i.e., approximately Rs. 4,000 crore, can be in the form of bonds issued/guaranteed by the

Government of India and will not have any immediate or direct impact on the governments budget excepting to the extent needed for interest servicing of the bonds. How much of this part of the restructuring cost finally ends up as an outgo for the government will depend upon the recoveries made by the ARF against the NPAs purchased from the banks and the improvements that result from the restructuring exercise in the profitability of the three banks. 7.160 The important point to note is that the restructuring programme will have to encompass operational, financial and systemic restructuring and must be implemented in a time bound manner. Any delay will add to the cost of the restructuring. In this context, it needs to be kept in view that the different measures suggested by the Group for operational, financial and systemic restructuring are a unified package and have to be implemented as such for the desired results to be achieved. Also, a stage has now reached when gradualism will not succeed and, in fact, if resorted to may cause more harm than good. By adopting a pick and choose approach, not only the total effect expected from the package will be lost, but even the individual measures picked up for implementation would lose much of their efficacy.
10 11

Reserve Bank of India (1997). Tarapore (1998). 2 1 Garcia (1997).

Chapter 8 Summary of recommendations 8.1 This chapter contains a summary of the recommendations made in different chapters of the report. Most major recommendations have been brought together and an effort has been made to place the recommendations in such a sequence that these have a flavour of the full report. The recommendations have been mentioned in brief. For knowing full details and rationale thereof, a reference to the relevant chapter and paragraphs would be necessary. Definition and identification of weakness in banks 8.2 The definitions of weakness prescribed by the Committee on Banking Sector Reforms (CBSR) stress on solvency and profit earning capacity of banks. These definitions are well considered and acceptable. In order to identify a banks weakness or strength with some degree of certainty, it would be desirable to use a few more specific tests in conjunction with the two suggested by the CBSR. (Paragraph 3.15) 8.3 Seven parameters have been selected for assessing a banks strength/weakness covering three major areas, namely, (a) solvency, (b) earning capacity, and (c) profitability. These are (i) capital adequacy ratio, (ii) coverage ratio, (iii) return on assets, (iv) net interest margin, (v) ratio of operating profit to average working funds, (vi) ratio of cost to income, and (vii) ratio of staff cost to net interest income (NII) + all other income. (Paragraph 3.16) 8.4 The tests provided in the CBSR report supplemented by an analysis of performance based on the seven parameters detailed above, should serve as the framework for identifying weakness in banks in future. (Paragraph 3.22) 8.5 These parameters can also be used to evolve benchmarks for competitive levels of performance by public sector banks. To begin with, these benchmarks should be set at the median levels of ratios relating to these parameters obtaining in the 24 public sector banks (excluding Indian Bank, UCO Bank and United Bank of India). (Paragraph 3.24) 8.6 Median levels of performance of public sector banks as benchmarks are only the initial benchmarks which these banks need to set for themselves. Gradually, these will have to be raised to be able to meet the compulsions of competition. (Paragraph 3.25) 8.7 The above approach serves the immediate objective of setting the criteria for diagnosing weaknesses in banks in general and for identifying the potentially weak banks. A database may, therefore, be built in respect of banks on an ongoing basis for the purpose of benchmarking and on the basis thereof identifying signals of weakness. (Paragraph 3.35) Restructuring strategy 8.8 For restoring weak banks to strength, restructuring is needed. Such restructuring is generally attempted by (a) merger or closure, (b) change of ownership, (c) operating

the bank(s) as narrow bank(s), or (d) undertaking comprehensive operational, financial and systemic restructuring. (Paragraph 7.6) 8.9 In our situation, merger or privatisation will not succeed unless the banks are brought to a minimum level of competitive efficiency. Narrow banking can, at best, be only a temporary phase and cannot, by itself, be adopted as a restructuring strategy. (Paragraphs 7.11, 7.15 and 7.22) 8.10 Closure has a number of negative externalities affecting depositors, borrowers, other clients, employees and, in general, the areas served by the banks being closed. This is an extreme option and would need to be exercised only after all other options have been ruled out. (Paragraph 7.12) 8.11 Comprehensive restructuring could succeed but it will involve firm and decisive actions in exercise of hard options. There will have to be a clear commitment from the owner, the government. It must display firm political will and generate an all-round consensus that the restructuring will go ahead without any let up or hindrance. The government, management of the banks and the employee unions must agree upon every important condition of the proposed restructuring programme before it is begun. (Paragraph 7.26) 8.12 The restructuring should cover operational, organisational, financial and systemic restructuring. Operational restructuring should involve basic changes in the mode of operations, adoption of modern technology, resolution of the problem of high nonperforming assets and a drastic reduction in cost of operations. Organisational restructuring would include improved governance of the banks and enhancement in management involvement and efficiency. Financial restructuring involves recapitalisation which may be done for specific purposes and with conditions which the banks management, including its Board of Directors, and the employee unions will agree to fulfil before the restructuring is begun. Systemic restructuring would provide for, inter alia, legal changes and institution building for supporting the restructuring process. (Paragraph 7.28) Main features of the restructuring programme for Indian Bank, UCO Bank and United Bank of India 8.13 Restructuring of the weak banks should be a two-stage operation. In stage one, focus should be on operational, organisational and financial restructuring aimed at restoring competitive efficiency. In stage two, the options of privatisation and/or merger will assume relevance. (Paragraph 7.29) Operational Restructuring Improving and diversifying sources of revenue 8.14 The weak banks cannot afford to lose further share in business and require to develop urgently capabilities to launch new products, attract new customers and bring about an overall improvement in housekeeping, MIS and risk management. (Paragraphs 7.34 and 7.35)

8.15 Each of the banks needs to develop strengths in chosen areas and build its skills and business strategy around those strengths. (Paragraph 7.36) 8.16 The three banks need to take urgent steps to reintroduce credit culture and ensure a rapid growth in non-fund based earnings. The large network of branches can be leveraged well to increase fee-based earnings by laying stress on selected services, particularly, movement and management of funds. (Paragraph 7.37) 8.17 The three banks must select areas of credit in which they have had experience and those where it is possible to develop expertise within a short time. The appropriate markets for them will be the middle and lower segments of the credit market as they need to concentrate more on the retail end of the business. (Paragraph 7.38) 8.18 Indian Bank and UCO Bank would find it extremely difficult to run their foreign branches in the short and medium term. These could be sold to prospective buyers including other Indian public sector banks subject to the necessary approvals. The resources so raised could fund some of the restructuring operations. (Paragraphs 7.41 and 7.42) 8.19 In the case of Indian Bank, a decision to pull out from the subsidiaries should be taken urgently. An effort should be made to find buyers for the banks holdings in the subsidiaries. (Paragraph 7.44) Introduction of modern technology 8.20 Operational restructuring can be begun best with a technology change. For weak banks, which do not possess either the finances or the skills for managing such a change efficiently, it is recommended that they go in for a common networking and processing facility, an arrangement which will bring the cost down substantially and also reduce the demand for skilled people. This common facility may be outsourced from a reputed IT system and solution provider, which will run the system for the banks. A Build Own Operate Transfer (BOOT) model may also be attempted for the purpose. (Paragraphs 7.48 to 7.50) 8.21 The IT programme should be aimed to be completed within twelve to eighteen months and to cover 70 per cent of the participating banks present business. Around 250 to 300 of the largest branches from each of the three banks should be networked under the proposed IT plan. The cost of implementing the technology strategy for the three banks is estimated at Rs. 300 to 400 crore which will have to come by way of cash/ transfer of funds. (Paragraphs 7.52 to 7.54) Handling of NPAs 8.22 Where guarantees have been given by the central or state governments and a demand thereunder has been raised by the banks, these demands should be honoured. (Paragraph 7.60) 8.23 Banks must put greater reliance upon the recommendations of the Settlement Advisory Committees (SAC) in order to make better use of compromises for reduction of

NPAs in their books. (Paragraph 7.62) 8.24 The most effective way of removing NPAs from the books of the weak banks would be to move these out to a separate agency which will buy the loans and make its own efforts for their recovery. (Paragraph 7.63) 8.25 The proper financial vehicle through which non-performing loans can be transferred would be that of the FRA-owned (government) Asset Reconstruction Fund (ARF) managed by an independent private sector Asset Management Company (AMC). (Paragraph 7.65) 8.26 The ownership of the assets will lie with the government and the management thereof with a separate private sector entity having the necessary expertise and organisation. (Paragraph 7.66) 8.27 The ARFs operations will be profit-oriented and its aim will be to recover from the acquired assets (NPAs) more than the price paid for it. (Paragraph 7.67) 8.28 The FRA and the ARF owned by it may be set up under a special Act of the Parliament which while protecting it against obstructive litigation from the borrowers could also provide for quick and effective enforcement of its rights against them. (Paragraph 7.68) 8.29 The fund needed for the ARF will be provided by the government. The size of the fund needed will depend upon the size of business it will handle. Presently, it is proposed that the ARF may restrict its activities to the NPAs of the three identified weak banks. (Paragraph 7.69) 8.30 The ARF should focus on comparatively larger NPAs. It would be desirable not to acquire assets valued below Rs. 50 lakh. NPAs of the three banks with face value above Rs. 50 lakh aggregated around Rs. 3,300 crore. Providing for nearly 35 per cent of the face value of the loan as its price, the ARF may need fund support in the region of Rs. 1,000 crore. (Paragraphs 7.70 and 7.71) 8.31 The payment in respect of the assets purchased from the weak banks may be made by the ARF by issuing special bonds guaranteed by the government and bearing a suitable rate of interest. The bonds may have a lock-in period of at least two years. (Paragraph 7.72) 8.32 The bonds issued by the ARF in payment of the assets acquired as also those which it will issue for raising funds against the security of assets it has purchased and which are in the course of collection may have a maturity of five years. (Paragraph 7.73) 8.33 The ARF should purchase from the banks loans, which are NPAs as on a certain date, say, 31 March 2000. In view of the foregoing it will be adequate for the ARF to have a life of not more than seven years from the date of its commencing business, say, beginning April 2000. (Paragraph 7.74) 8.34 To begin with, the ARF may buy NPAs of only the three identified weak banks.

However, buying NPAs from other banks need not be totally excluded. (Paragraph 7.75) 8.35 If need arises, more Funds could be set up later. Such subsequent funds could be area-specific, bank-specific, for a group of banks or for the entire sector. Participation in these funds may be open to both public and private sector. These funds can facilitate growth of secondary market for loans in the country. (Paragraph 7.76) 8.36 Price at which NPAs will be transferred should be arrived at by mutual agreement and in a transparent manner. It is, therefore, not considered necessary to prescribe either a floor price or a formula therefor. (Paragraph 7.79) 8.37 The management of the ARF should be entrusted to an independent Asset Management Company which can be compensated for its services in the form of service commission and incentives. (Paragraph 7.80) 8.38 In the ownership of the AMC, while the government may have a share of up to 49 percent, majority shareholding should be non-government. Institutions like SBI, LIC, GIC, UTI and IFCI and parties from the private sector could be the other shareholders. The possibility of attracting participation of multilateral agencies like IFC or ADB should also be explored. The initial capital requirement of the AMC is not likely to be more than Rs. 15 crore. (Paragraph 7.81) 8.39 The AMC, which must have a lean structure, should be manned by professionals such as bankers, chartered accountants, engineers, lawyers and valuers so that it has the desired expertise and is cost efficient. (Paragraph 7.82) Cost reduction 8.40 The cost of operations of the three banks has reached unsustainable levels and must be brought down urgently. They must bring it in line with, at least, the average performing public sector banks in terms of its percentage to total operating income. (Paragraph 7.87) 8.41 Unless significant operational, organisational and financial restructuring as suggested takes place, high staff expenses will continue to keep the operating expenses of these banks close to or even in excess of their operating income. (Paragraphs 7.94 and 7.95) 8.42 A 30-35 per cent reduction in staff costs is required in the three banks so that the ratio of staff costs to operating income in these banks comes to the median level of the same ratio in public sector banks. (Paragraph 7.100) 8.43 UCO Bank has also identified a similar surplus in its staff strength. Considering all factors like expected income growth in future and removal of NPAs, initially, a reduction in the staff strength of the order of 25 per cent is recommended. (Paragraph 7.101) 8.44 In order to control their staff costs, the three weak banks will have to resort to a voluntary retirement scheme (VRS) covering at least 25 per cent of the staff strength. A

reasonable VRS for the three banks aimed at 25 per cent reduction in overall staff costs is expected to cost anywhere between Rs. 1,100 and Rs. 1,200 crore. (Paragraphs 7.104 and 7.105) 8.45 While giving effect to VRS, the banks should endeavour to maintain in the remaining staff strength a good balance between different categories of staff. (Paragraph 7.106) 8.46 The scheme should be kept open for a period not exceeding six months so that consequential actions to be taken are not delayed. (Paragraph 7.106) 8.47 The banks will also need to undertake considerable retraining and relocation of the post-VRS staff strength and ensure changes in the job content and skills of the different categories of employees so that their services can be put to best use at points where these will be needed most. (Paragraph 7.107) 8.48 In order that the VRS and the needed reduction in staff costs have a real impact on the operating results of the banks concerned, it would also be necessary to place a cap on the staff expenses of the three banks. A five-year freeze on all future wage increase including the one presently under contemplation is considered necessary. (Paragraph 7.108) 8.49 If VRS does not lead to the needed reduction in the banks operating costs, there will be no alternative to an across-the-board wage cut enabling a 25 per cent reduction in staff costs. (Paragraph 7.109) Organisational restructuring 8.50 In all the three banks, urgent delayering of the decision making process relating to credit is called for without which loss of business will be very difficult to arrest. (Paragraph 7.114) 8.51 These banks have a larger network of branches than what their level of business needs or can sustain. At a fairly large number of centres, branches of the same bank are only eating into each others potential. There is, therefore, an urgent need to consider rationalisation of branches in all the three weak banks. (Paragraph 7.115) 8.52 The weak banks must take a hard and careful look at their branches which are unviable and after convincing themselves about their unviability decide to discontinue these operations. By continuing such operations hoping that these will improve in future or by showing them artificially as profitable using a transfer pricing mechanism which favours them unduly, the problem will be compounded and elude solution even in future. It therefore stands to reason that the banks merge two or more unviable operations into one viable operation. (Paragraph 7.118) 8.53 The CMD in a weak bank has to possess special skills and attitude helpful in restructuring of an organisation. Incumbents in these positions need to be proven achievers who can lead from the front. (Paragraph 7.119) 8.54 It is equally important that the CMDs of these banks have a sufficiently long

tenure, say, a minimum of four to five years for effectively discharging the complicated task of restructuring a bank and should be in the age group of 50-52 years. In order to ensure uninterrupted progress of the restructuring plan and to commit the top management thereto fully, this tenure should not be ordinarily curtailed. (Paragraph 7.120) 8.55 The right persons for these jobs should be provided with incentives, both monetary and non-monetary, for achieving the restructuring mission successfully even if giving such incentives means making a departure from the existing norms. (Paragraphs 7.121 and 7.122) 8.56 A line of succession should be developed well in time and a system put in place whereby, save exceptions, an ED should succeed the outgoing CMD. Excepting in very small banks, there should be two EDs. (Paragraph 7.123) 8.57 In weak banks, there should be two EDs as it is desirable that a very senior functionary, besides the CMD, should be charged with the responsibility of driving the restructuring process leaving the CMD free to pursue other strategic growth issues. (Paragraph 7.123) 8.58 The Boards of these banks need to be reconstituted to include eminent professionals, industrialists and financial experts with the necessary training, experience and background to provide strategic support to the CMDs team. Board level support to the banks management in strategising, decision making, target monitoring and course corrections has to be regular and extensive and the Boards need to have not only the talent and will but also a cohesive and focused approach to do it. It is important for the weak banks that their boards function as totally cohesive bodies. (Paragraph 7.124) 8.59 There should be a clear distinction between the roles of ownership, which the government has, and that of management, which it doesnt. As a first step in the direction, the government may consider withdrawing from the banks boards its own serving officers and replace them with independent nominees having relevant knowledge and background. (Paragraph 7.125) 8.60 While a longer term training and reskilling programme will have to be undertaken by the banks, they would also need to resort to some recruitment in the senior and middle levels of management from the market. Provision would need to be created for such recruitment by them. Arrangements should also be made for lateral movement of talent. (Paragraph 7.128) 8.61 The training facilities in the banks will have to be considerably strengthened. It is also worth considering whether training facilities created by more than one bank could be pooled for better and optimum utilisation of the facilities and limited training skills. A sub-allocation out of the capital support earmarked for HR including VRS may be made for reskilling and training. (Paragraph 7.129) Financial restructuring 8.62 For maintaining a good loan book as also a balanced overall asset profile, banks

need to maintain at all time CAR at a level comfortably above the minimum required. Financial restructuring of a bank should aim at raising its CAR to at least one per cent above the minimum required so that it can continue with its credit business normally. (Paragraph 7.135) 8.63 A portion of the additional capital requirement would need to be provided in cash. As a measure of introducing some accountability for using additional funds, the weak banks must undertake to provide a return. At least, on such portion of capital funds, which are provided in cash/by transfer of funds, there needs to be an arrangement, even if deferred, for payment of interest. The government may decide to bring in such capital by way of preference capital or subordinated debt forming a part of Tier II capital of banks. (Paragraph 7.137) 8.64 Further recapitalisation must be accompanied by strict conditionalities relating to operational as well as organisational restructuring of the recipient bank. There should also be conditionalities about the manner in which these funds can be deployed and about their servicing. An expectation of continued recapitalisation without any limit is just not sustainable. (Paragraph 7.139) 8.65 Future capital infusions in weak banks should be clearly earmarked for specific purposes indicating the amount that could be used under the head as also the period within which it could be utilised. Funds should become available only when the banks undertake the specific activities for which these have been earmarked. An account with the government or with the RBI could be opened from which earmarked funds could be made available. (Paragraph 7.141) 8.66 Considering the present financial condition of the banks, the government may decide to give them moratorium on payment of interest for one or two years, i.e., until the deployment of these funds starts getting reflected in their operating results. The agreed rate of dividend on such preference shares and interest on subordinated debt may not be market-related and kept low. (Paragraph 7.142) 8.67 All future recapitalisation should be under an agreement, between the government on the one side and the banks Board of Directors, its management and staff and employee unions on the other, laying out the restructuring goals. It would also be desirable to assign selected financial indices for the bank to follow within a timeframe. The performance under this agreement will have to be monitored closely. (Paragraph 7.143) 8.68 The cost of comprehensive restructuring of the three banks over the next three years is estimated to be of the order of Rs. 5,500 crore, Rs. 2,500 crore for operational restructuring and about Rs. 3,000 crore to meet the requirements of financial restructuring. Out of this, about Rs. 1,500 crore will be needed in cash and the rest in the form of bonds. (Paragraph 7.111) 8.69 The broad pattern of strategies proposed and the experience gained from their implementation should form basis of future restructuring programmes that may be evolved for other banks which show signs of distress. (Paragraph 7.31)

Systemic restructuring 8.70 It is considered necessary that an independent agency established under a special Act of the Parliament be entrusted with the responsibility of approving bank-specific restructuring programmes, initiating their implementation and monitoring progress. This will be the Financial Restructuring Authority (FRA). (Paragraphs 7.144 to 7.146) 8.71 The FRA set up under an Act of the Parliament and working as an arm of the government will facilitate coordination between the banks being restructured, the government and the regulatory authorities. (Paragraphs 7.144 to 7.146) 8.72 The basic control of banks covered by the restructuring will continue to be with the Ministry and there will be no change in the Reserve Bank of Indias role of regulation and supervision. (Paragraph 7.146) 8.73 The FRA will monitor the progress of the restructuring programme and will have the powers to take all decisions relating thereto which the owner needs to take. Its role and functions would need to extend over the policy as well as operational aspects of the restructuring programme. Among other things, it will be the owner of the Asset Reconstruction Fund on behalf of the government and will ensure its proper governance and arrange for the management of the ARF by appointing Asset Management Companies. (Paragraph 7.146) 8.74 The FRA may be established under a special Act of the Parliament with provisions protecting it against avoidable obstructive litigation and also from the necessity of legal procedures in enforcement of mortgages and other contractual rights. (Paragraph 7.149) 8.75 The FRA will not be a permanent body as it is expected that, with the completion of the restructuring process of the weak banks, it would be wound up. (Paragraph 7.150) 8.76 The FRA should be able to ensure a high level of coordination with the regulator on the one hand and the government on the other so that the restructuring programme moves ahead smoothly. The process will be facilitated substantially if within Reserve Bank of India, a specialist wing is formed for regulating and supervising weak banks. On a number of issues like deposit insurance, regulation of subsidiaries, risk management, disclosures and regulatory compliance, the treatment of weak banks would need to be different from those of much stronger normal banks. (Paragraph 7.151) 8.77 The legal provisions, which are out of line with the present day realities, need to be amended and new enactments, particularly in respect of laws relating to bankruptcy, a defaulters handling of assets which were offered as collateral for a loan, foreclosures and court procedures, are urgently required in order to cater to the requirements of the present changed and far more complex economic and business environment. (Paragraph 7.152) 8.78 A secondary market in loans should be developed but this would be possible only if the legal provisions facilitating hassle-free transfer of loans and recovery of dues are in place. (Paragraph 7.154)

8.79 For speeding up the recovery process of weak banks and the ARF, an arrangement should be worked out so that the DRTs attend to their cases on a priority basis. At least at some select centres, setting up of special benches of DRTs to assist weak banks and the ARF should be considered to give recovery of NPAs the much desired push. (Paragraph 7.156) 8.80 The investigations into accountability both at the bank and at the level of nonbank agencies if completed in a time-bound manner would go a long way in ending uncertainties and help in the overall improvement of morale of the staff. (Paragraph 7.158) Concluding remarks 8.81 The restructuring programme must be implemented in a time-bound manner. Any delay will add to the cost of the restructuring. (Paragraph 7.160) 8.82 The different measures suggested for operational, organisational, financial and systemic restructuring are a unified package and have to be implemented as such for the desired results to be achieved. Gradualism and a policy of pick and choose from the package should be avoided as it can cause more harm than good. (Paragraph 7.160)

List of abbreviations ADB ALCO ALPM AMC AMK ARC ARF ATM BHEL BIFR BOOT BSA CAR CBSR CD CEO CMD CRAR CRISIL CRR CVC DBP DRT ED EDI FDIC FSRA FRA FSC FSLIC GDP GIC GITIC GOI IBHL IBMBS IBRA ICD ICRA IFC IFCI IFML Asian Development Bank Asset Liability Management Committee Advanced Ledger Posting Machine Asset Management Company Asset Management Kredit (Indonesia) Asset Reconstruction Company Asset Reconstruction Fund Automated Teller Machine Bharat Heavy Electricals Ltd. Board for Industrial and Financial Reconstruction Build Own Operate Transfer Bank Support Authority (Sweden) Capital Adequacy Ratio Committee on Banking Sector Reforms Certificate of Deposit Chief Executive Officer Chairman and Managing Director Capital to Risk-weighted Assets Ratio Credit Rating and Information Services of India Limited Cash Reserve Ratio Central Vigilance Commission Development Bank of Philippines Debt Recovery Tribunal Executive Director Electronic Data Interchange Federal Deposit Insurance Corporation Financial Sector Restructuring Authority (Thailand) Financial Restructuring Authority Financial Supervisory Commission (Korea) Federal Savings and Loans Insurance Corporation Gross Domestic Product General Insurance Corporation Guangdong International Trust and Investment Company Government of India IndBank Housing Ltd. IndBank Merchant Banking Services Ltd. Indonesian Bank Restructuring Agency Inter Corporate Deposit Investment Information and Credit Rating Agency International Finance Corporation Industrial Finance Corporation of India IndFund Management Ltd.

IIBI IMF IRBI IT KAMCO KDIC LIC M&A MIS MOFE MOU NABARD NIBM NII NIM NPA OBS P&A PNB PSBs RBI RRB RTC S&L SAC SBI SEBI SFCs SIDBI SRP UBI UTI VRS

Industrial Investment Bank of India International Monetary Fund Industrial Reconstruction Bank of India Information Technology Korea Asset Management Corporation Korean Deposit Insurance Corporation Life Insurance Corporation of India Mergers and Acquisitions Management Information System Ministry of Finance and Economy (Korea) Memorandum of Understanding National Bank for Agriculture and Rural Development National Institute of Bank Management Net Interest Income Net Interest Margin Non-Performing Asset Office of Bank Supervision (Korea) Purchase and Assumption Philippines National Bank Public Sector Banks Reserve Bank of India Regional Rural Bank Resolution Trust Corporation Savings and Loans Institutions Settlement Advisory Committee State Bank of India Securities and Exchange Board of India State Financial Corporations Small Industries Development Bank of India Strategic Revival Plan United Bank of India Unit Trust of India Voluntary Retirement Scheme

Annex 1 Letter addressed to Shri M.S. Verma regarding constitution of the Working Group DEPUTY GOVERNOR RESERVE BANK OF INDIA, CENTRAL OFFICE, SHAHEED BHAGAT SINGH ROAD, MUMBAI 400 001. INDIA.

D.O. DBOD.BP.2059/21.04.110/99 February 6, 1999 Dear Shri Verma, Working Group on Restructuring of Weak Public Sector Banks It has been decided to set up, in consultation with the Government of India, a Working Group under your Chairmanship, to suggest measures for revival of weak public sector banks with the following members: (i) Shri K.R.Ramamoorthy, Chairman, Vysya Bank Limited, Bangalore,

(ii) Shri M.M. Chitale, Chartered Accountant (former President, Institute of Chartered Accountants of India), (iii) Shri P.K.Choudhury, Managing Director, Investment Credit Rating Agency, New Delhi, (iv) Shri J.R.Prabhu, former Executive Director, Reserve Bank of India, and

(v) Dr. Sushil Chandra, former Director, International Management Institute, New Delhi. 2. The terms of reference of the Working Group are as under: [a] Criteria for identification of weak public sector banks; [b] To study and examine the problems of weak banks; [c] To undertake a case by case examination of the weak banks and to identify those which are potentially revivable; [d] To suggest a strategic plan of financial, organisational and operational restructuring for weak public sector banks. Shri C.R. Muralidharan, General Manager, Reserve Bank of India, Department of Banking Operations and Development, Central Office, Mumbai, will be the Member Secretary. The report of the Working Group may please be submitted to us by 30th June, 1999. With regards, Yours sincerely,

Sd/[S.P. Talwar] Shri M.S. Verma, Hon. Advisor to the Reserve Bank of India, Reserve Bank of India, Main Building, Mumbai. Annex 2 Questionnaire sent to the three weak banks NAME OF THE BANK: PROFILE (as on 31.03.99) A. (i) Number of offices and staff No. of people Award Staff

ADMINISTRATIVE Head Office Zonal Offices Divisional Offices Total OPERATING Branches Sub-branches/offices/ extension counters Total GRAND TOTAL (ii) Geographical spread INDIA: Name of the State

Supervisory

Administrative offices HO ZO Div.

Operating offices SubExtension Branches branches counters

ABROAD: Name of the Country Administrative offices HO ZO Div. Operating offices SubExtension Branches branches counters

(iii) Staff concentration Concentration Category Very large (with more than 300 employees) Large (101 300) Big (51 100) Medium (21 50) Small (8 20) Very small (7 1) B. (i) Business Handled 1997-98 Amount Market Share Aggregate deposits Aggregate advances Net profit/losses Accumulated losses, if any (ii) Business Concentration In terms of deposits (%) 10 largest branches In terms of advances (%) In terms of profits (%) 1998-99 1999-2000 Amount Market Amount Market Share Share Head Office Zonal Office Divisional Offices Branches

account for 25 -do50 -do100 -do300 -do500 -doNote: Largest for the purpose means largest for the particular kind of business, i.e., deposits or advances (iii) Profit dispersal amongst branches Metropolitan Urban Semi-urban Rural Total Profit making Loss-making

GENERAL STATE OF AFFAIRS Current and projected basic ratios indicating financial strength: 31 March 1998 Capital adequacy ROA (Return on assets) ROE (Return on Equity) Equity on Asset Non-performing Loan/ Total Loan Non-performing Assets/ Total operating revenue Total Expense/Total Income Non-interest expense/ operating revenue Where projections are made, assumptions behind these projections should be stated clearly. Such assumptions could be about markets, management of NPAs, asset restructuring and recapitalisation. The extent of additional recapitalisation required and the expected source from which such recapitalisation is expected should also be stated. STRATEGY 1. Position in the industry / market 31 March 1999 31 March 2000 (Projected) 31 March 2001 (Projected)

1.1 How do you view the future of commercial banking in India in the next 3/5 years in

terms of number and type of players and the impact of competition on this structure? 1.2 What is your banks vision and objectives? What positioning do you envisage for your bank in the market; a bank with countrywide importance, regional importance or operating in a niche or any other. In your view what will be your share of business in the total market? 1.3 Do you have a strategy charted out to achieve the above stated vision/ objective? Will there be any pre requisites, preconditions for you to be able to implement the desired strategy? Operating strategy 1.4 How precisely (i.e. by changing customer focus, modifying product line, reduction in cost of delivery, identifying new businesses and converting them into additional streams of revenue, improvement in technology etc.) will you meet the intensifying competition in the sector. How, in particular, do you expect to fare against the highly technologically advanced private sector/ foreign banks that are also largely free from any legacy of the past ? 1.5 Do you have and/or expect to develop any distinctive strategic advantage and skill sets, which will drive your product/customer focus in the revival strategy? 1.6 What levels of Net interest margin (NIM), Net interest income (NII) ratio of Noninterest income to total income, expense ratio, do you estimate will be necessary for you to be able to generate an acceptable return on equity say 15%? Corporate Governance 1.7 Do you consider that any change in the structure of your Board of directors will be helpful in your implementing the desired strategy. If so, what kind of structural changes in the constitution of the Board are considered desirable? 1.8 Do you expect the Board to play a decisive role in setting strategy and overall performance targets? 1.9 Is the current decision making process in your bank, particularly relating to credit and investments seen as sound and quick so as to ensure retention of present clients and acquisition of acceptable new ones? If you envisage any changes therein, what would these be? Management 1.10 How do you propose to organise your core team to drive change and implement the revival strategy successfully? 1.11 How do you propose managing the basic problems of acquiring a reasonably good number of new clients and retaining the existing ones? What are the required investments and resources to do so? 1.12 Does your bank have a reasonably good percentage of high performers at different levels amongst your total staff strength (say, 12 15%) upon whom reliance could be

placed to drive the revival strategy? In the present none-too-enthusing scenario how do you propose to keep them motivated? What kind of scheme of empowerment and/or incentive(s) would help you place the bank on the path to long term profitable performance? Organisational structure 1.13 Is the banks organisational structure adequate to achieve its current objectives? Do you consider any change therein necessary? 1.14 Has any attempt been made or is being made to effect any change in the structure? What is your estimation of the financial and human resources required for effecting the desired change? 2. Business capability

2.1 Are there any clearly identified skill strengths in each or any of your major business lines today? 2.2 Are there any identified skill gaps? Do you think that these gaps can be closed effectively within a reasonable time so as to ensure that future of the bank is not jeopardised? 2.3 What is your plan to close the gap? Has it been initiated already and how long do you think it will take to complete? 2.4 What is the Banks present efficiency ratio (as on 31.3.98 and 31.3.99)? 2.5 What is the efficiency ratio, you think the Bank will achieve by the end of 1999-2000 and 2000-2001? Technology 2.6 What is the extent of computerisation achieved in your bank so far? Please indicate in terms of: (A) Business (a) Number of branches computerised (i) (ii) only back office full branch

(b) Percentage of total business covered by computerisation (i) (ii) Deposits Advances

(iii) Other business (B) Percentage of total M.I.S. covered by computerisation

2.7 Has the Bank at present a working ALM system. Is the M.I.S. in the bank aligned to the ALM system ? 2.8 Does the bank have any system for credit scoring, credit portfolio management and early warning systems? 3. Management of Non-performing Assets

3.1 What is the percentage of Non-performing assets to Aggregate assets? 31.3.97 Gross Net Please give market segment-wise details. Also indicate what % of the total is represented by the top 200 accounts under each head. 3.2 What is the percentage of Non-performing loans to Aggregate loans? 31.3.97 Gross Net Please give market segment-wise details. Also indicate what % of the total is represented by the top 200 accounts under each head. 3.3 What is the current estimate of Losses from : (i) (ii) Net non-performing assets Net non-performing Loans 31.3.98 31.3.99 31.3.2000 (projected) 31.3.98 31.3.99 31.3.2000 (projected)

Please state separately the extent of security cover available in respect of NPAs (independent of provisions) 3.4 Has any special set-up been created within the bank to address the problem of NPA? If so, please provide details (organisation, processes, number and amount of accounts specially focussed upon as well as success achieved so far/likely to be achieved in future. 1997-98 By upgradation Recoveries Compromise settlements Write-off Total 1998-99 1999-2000 2000-2001

3.5 What is the current rate of N.P.A. generation? (calculated as % of new NPAs identified during a year to aggregate performing assets/Loans at the beginning of the year) 3.6 Would you favour the idea of transferring whole or part of your banks NPAs to a separate Asset reconstruction company (ARC)? 3.7 Would you favour the idea of transferring NPAs to an independent ARC even if the transfer value agreed upon turns out to be lower than their book value? 3.8 What do you suggest should be the criteria for transferring assets to the proposed ARC? 3.9 Based on the criteria proposed by you what are the numbers and amount of your NPAs, which will get transferred to the ARC? 3.10 What will be the projected results of the transfer of NPAs (a) Impact on existing earning assets (b) Impact on growth of assets (c) Impact on required provision levels (d) Impact on the banks profitability 3.11 Have you any alternative/additional plan for handling your banks NPAs already under implementation or proposed to be implemented shortly? Please give details and its expected impact. 4. Financials Cost and Revenue Revenue

4.1 Are the margins available on your different products adequate to render the overall operations of the bank profitable? 4.2 In respect of which of your banks revenue sources, you think an increase is likely and/or anticipated in the near future. Have you initiated or are likely to initiate in the near future any measures to achieve? 4.3 What will be the impact of such increase(s) on your banks profits and by when? 4.2 What is your banks present level of Non-interest income and what improvement therein is planned in the next three years? Give details of these plans and their operationalisation? Cost 4.5 What is your current efficiency ratio and what are your plans for improving it in the years 1999-2000, 2000-2001 and 2001-2002? 4.6 Does the Bank have any plans for productivity improvement? Give details and an idea of the time frame in which its results can be visible. 4.7 What management process do you plan to use to measure and monitor productivity improvement in each major business segment and back/front office functions? 4.8 If margins and levels of business do not improve substantially in the near future there will be no alternative to cost reductions. What plans in these regards can be followed?

a. Reduction in the number of branches b. Reduction in the number of staff, say, by way of VRS c. Wage freeze/cut d. Others 5. Need for recapitalisation

5.1 Based on stipulated capital adequacy requirements as also the proposed business plans and the financial projections, what would be the required recapitalisation as at the end of the years 19992000, 200001 and 2001-02. 5.2 What would be the proposed source of the recapitalisation and can it be reasonably assumed on the basis of currently available indications that the anticipation in regard to the source is realistic? 6. Future potential

6.1 Has the bank been successful in retaining customers in the past two years, i.e., 97-98 and 98-99? 6.2 How many new accounts (other than advances in the priority sector under different government sponsored schemes) were opened in the past two years?

Advances Corporate Retail Total

1997-98 Deposits

Advances

1998-99 Deposits

6.3 (a) Have you conducted any retail customer satisfactory survey in the past 2 years? (b) Have you conducted any commercial customer satisfaction survey in the past 2 years? 6.4 Does your bank have a System/M.I.S., which can calculate profit by customer segment/product line/individual customer? 6.5 Are the accounting system and the M.I.S. in the bank designed to give a reasonably precise idea of the cost involved in offering any product/ service to the clients? FINANCIAL STATEMENT BALANCE SHEET (Rs. crore) Past Performance Projections 1997 1998 1999 2000 2001 2002 2003 2004 Assets Cash, bank deposits, money

Markets Recapitalisation Fund (Bonds) already received Loans Performing (Provisions for Loans) Loans Non performing (Provisions for Loans) Government Securities Corporate Debentures Equity (Provision for securities) Fixed assets Other assets Total Assets Liabilities and Equity Deposits Demand Deposits Savings Money Market funding Borrowing domestic Borrowing foreign Other liabilities Total Liabilities Net Assets (Liabilities) Shareholders equity FINANCIAL STATEMENT PROFIT AND LOSS STATEMENT (Rs. crore) Past Performance Projections 96/97 97/98 98/99 1999/ 2000/ 2001/ 2002/ 2003/ 2000 01 02 03 04 Total interest income Total interest expense Net interest income (NII) % of operating revenue Other income (e.g., investments) Other expenses (FX.,investment) Non interest income % of operating revenue Total net revenue (Operating revenue) Provisions for loan losses Staff expenses Other operating expenses

Total non interest expense (Other expense) Profit/(loss) before tax Income Tax % NET INCOME/(LOSS) Annex 3 Constitution of sub-groups Name of the Bank Indian Bank Members Shri P.K. Choudhury

Member of Working Group Shri K. R. Ramamoorthy Member of Working Group Shri R. Raghuttama Rao Executive Director, ICRA Advisory Services Shri V. Sriram Consultant, ICRA Advisory Services Shri N. Mahesh Consultant, ICRA Advisory Services Shri G. Sreekumar AGM and EA to Hon. Adviser, Reserve Bank of India UCO Bank Dr. Sushil Chandra Member of Working Group Shri J.R. Prabhu Member of Working Group Shri C.R. Muralidharan Member Secretary of Working Group Ms. Anjali Gupta Asst. Vice President, SBI Capital Markets Ltd. United Bank of Shri M.M. Chitale Member of Working India Group Shri Kishore Gandhi Director, CRISIL Shri George Mathew Manager, CRISIL Shri N. Shankar Manager, CRISIL Shri Pathik Gandotra Manager, CRISIL Ms. Sudha Damodar Deputy General Manager, Reserve Bank of India Note: The sub-groups were also assisted by General Managers of the respective banks. Annex 4 Sub-group report on Indian Bank Executive Summary

1. Indian Bank has a four-tier organisation structure. The bank has 1,492 domestic branches and 34 regional offices, which are controlled by 11 zonal offices. More than 60 per cent of the branches are in semi-urban and rural areas. Nearly three-fourths of the branches are in the southern states. The bank has lead bank responsibility for 13 districts spread across three states and one union territory. Gross profit of all the four RRBs sponsored by the bank was Rs. 10.34 crore as on 31 March 1999. 2. The financial position of the bank has steadily deteriorated over the last five years. The accumulated losses as on 31 March 1998 amounted to Rs. 2,403 crore. With the losses for 1998-99 expected to be about Rs. 850 crore, the accumulated losses will amount to Rs. 3,253 crore as on 31 March 1999. With the exception of one year (199495), the bank has posted operating losses for the last six years. In 1994-95, the bank was able to post a profit on account of non-classification of certain assets as non-performing. 3. The bank has a capital of Rs. 2,503.96 crore as on 31 March 1999. It has received special securities and recap bonds aggregating Rs. 2,484.96 crore at varying coupon rates. An infusion of Rs. 1,750 crore was made in February 1998 based on a strategic revival plan. Capital adequacy turned positive after two years and reached 1.41 in March 1998 but will again turn negative in March 1999. 4. Though the bank was able to achieve the targets in terms of resource mobilisation and the deployment of funds, there was a sharp reduction in net interest income of the bank on account of high interest rate risk. The inherent weak position and poor earnings of the bank was accentuated by a fall in interest rates during 1997-98. 5. The reasons for the banks continued poor performance are: a. High levels of non-performing assets. b. High operating expenses compared to earning assets. c. Funding of accumulated cash losses. d. Adverse movement of interest rates. 6. The problems of the bank can be classified into two phases. The first phase covers the pre-1996 period when there was a gradual deterioration in all areas of banking, viz., quality of advances, reliance on high cost funds, slow growth in core deposits and poor governance. This phase saw a period of excessive unplanned credit growth between 1988 and 1992. While credit grew at a CAGR of 28.8 per cent, deposit grew at 21.1 per cent resulting in excessive borrowings. The bank was subjected to high interest and liquidity risks given the nature of funding sources and the interest cost on borrowing reached a peak of 20.9 per cent during 1991-92. 7. The Reserve Bank of India imposed restrictions on credit expansion in August 1992. The period 1992 to 1994 saw a modest credit growth of 7.8 per cent and a deposit growth of 17.8 per cent. However, the effect of the previous unplanned credit growth started to show up. In 1994, when the Reserve Bank lifted the credit embargo, the bank once again resorted to credit growth in excess of core deposit growth and ended up borrowing nearly Rs. 3,000 crore during 1995-96 to fund the growth. The credit growth was in new and high-risk areas. The bank ran a huge asset liability mismatch and interest

risk. With high levels of NPAs, poor quality of advances in high-risk sectors and an unfavourable asset liability position, the bank started making huge losses from 1996 onwards. 8. The post-1996 phase was characterised by a structural problem. The huge NPAs and asset liability mismatch were an overhang on the bank. The initial years in this period were devoted to cleansing operations of bad loans and implementing of control systems. The bank was concentrating more on correcting the asset liability mismatches by restructuring the liability side of the balance sheet. Credit sanction was centralised at the head office and the operational tiers were directed to concentrate on recovery. 9. The cleaning up operations entailed stringent disciplinary action within the bank. This resulted in a spate of cases being opened up on advances sanctioned during the earlier period. This acted as a dampener in decision making and there was and continues to be reluctance in decision making at all levels. This has resulted in the bank making no progress in disbursing fresh credit or in recovering bad loans. The only area in which the bank performed reasonably was deposit mobilisation. Recently, there has been a relaxation in the credit sanction policies and the discretionary powers of the various authorities have been restored. 10. The lack of direction in terms of growth targets and upgradation of skills have left the bank in a state of organisational paralysis. There is no will to take decisions at the operating level. The excessively long time taken to process credit and compromise proposals for non-performing assets has resulted in loss of business. 11. The lack of business growth and the high levels of NPAs resulted in a disproportionate increase in wage costs as compared to the earning assets of the bank. While the wage costs increased at the average industry rates, the balance sheet of the bank shrunk. Thus, the bank has an inherently adverse cost structure. 12. The bank achieved an average deposit growth of 15 per cent over the last three years though much of it was in high cost term deposits. Credit grew at an average of about 5 per cent mainly due to food credit. In terms of non-food credit there was a decline in 1996-97 and 1997-98. As a consequence of low credit growth, the fee income has also suffered. Further, the discretionary powers of branch managers for purchase of cheques and drafts were withdrawn. 13. The bank concentrated on large value corporate credit during most of 1998-99. Most of the sanctions were to reputed corporate houses at the prime lending rate (PLR). Of late, there seems to be a change in the focus towards the mid-corporate and trade segments where it could charge an interest of PLR + 3 or 4 per cent. With the restoration of discretionary powers to the field officials, the bank expects to increase credit to these segments at higher rates. 14. The bank is not active in its treasury operations. The financial position of the bank precludes it from taking any significant risk. The bank is presently in the process of training its personnel in trading and has made a modest beginning in this area.

15. Due to lack of growth in credit, the non-interest income to average total assets was only 0.57 per cent as against the median of 3.32 per cent for profitable public sector banks. 16. Operating expenses to total income increased from 29 per cent in 1996-97 to 34 per cent in 1997-98 and further to 38 per cent in 1998-99. The cost income ratio for the bank works out to 117 per cent for 1997-98. This is way ahead of the industry levels. The expenses are not sustainable at current levels of business. 17. Out of total NPAs of Rs. 3,428 crore in 1997-98, Rs. 3,029 crore pertain to domestic operations. Domestic provisions amount to Rs. 1,100 crore. Non-priority sector accounts for 62 per cent of total NPAs. This includes advances disbursed during the early nineties in new areas such as real estate, films, hospitals and educational institutions. Though bulk of the NPAs is in the non-priority sector, more than 50 per cent of the recovery is from smaller priority sector accounts. Recovery in large value NPAs is poor. As a result of the poor recovery, NPAs have slipped into the doubtful category necessitating additional provisions; the efflux of time also makes them more difficult to recover. 18. The bank has a compromise policy for recovery of NPAs. Though the policy of the bank is to effect maximum recovery through compromise, it has not been able to achieve any significant recovery through this route. In fact, the number of compromise proposals put up to the head office has been on the decline over the last three years. Lack of clarity in the policy and delayed decisions at higher levels have contributed to this decline. Multiple layers in the sanctioning process, use of different formats at different levels and rejection of proposals without assigning any reason are some of the other reasons for the decline. The recently revised compromise policy is expected to provide better results. 19. There is a general perception in the bank that top management is not very keen to effect recovery. This has affected decision making at lower levels. The poor recovery of NPAs coupled with a very high slippage has crippled the earnings of the bank. The bank added fresh NPAs to the tune of Rs. 1,000 crore in the last three years. 20. The domestic net credit has been stagnant at around Rs. 7,000 crore during the three years ended March 1998 even as deposits grew steadily. As a consequence, the credit deposit ratio fell from 63 per cent in March 1996 to 49 per cent in March 1998. This was mainly due to centralisation of all lending decisions at the head office. 21. More than 70 per cent of the large-value large and medium industry accounts fall within the potentially weak category. The bank could experience very high NPA generation rate over the medium term unless account-specific remedial measures calling for significant organisational effort at all levels are taken. New asset creation process will have to be more stringent as the current risk profile of the portfolio does not allow for taking on any new high risk accounts. 22. The credit appraisal system captures the basic details but fails to capture riskrelated aspects. Large value proposals pass through a number of tiers before reaching the sanctioning authority but there is no value addition at most of the tiers.

23. The bank has two branches in Colombo and one in Singapore which together have 543 employees. Total NPAs in international operations amounted to about Rs. 400 crore as on 31 March 1998. This is expected to increase by more than Rs. 200 crore during 1998-99. The provision for Singapore NPAs is expected to be Rs. 170 crore for 1998-99 and with this the branch is expected to post a net loss of about Rs. 140 crore as on 31 March 1999. The banks high cost of funds leads to an unfavourable client profile. The level of NPA is very high and has led to a low interest spread. The bank lacks the necessary treasury skills in a market with free capital flows. 24. An amount of Rs. 35 crore on account of ICDs given by the housing subsidiary is likely to devolve on the bank. Despite capital infusion, the net worth of the housing subsidiary will be negative in the foreseeable future owing to write-off of ICDs, interest accrued on ICDs and non-performing project loans. 25. In the case of the mutual fund subsidiary, the total liability towards all schemes stands at Rs. 123.67 crore. Of this, only Rs. 0.42 crore is expected to be met from profits. While Rs. 43.71 crore has already been paid by the bank (this has been treated as investments and not yet written off), the bank will have to pay a further amount of Rs. 79.54 crore during this financial year. The bank will have to fund the mutual fund to the extent of Rs. 75 crore towards schemes where indicative returns have been committed by the fund. 26. The merchant banking subsidiary has reported a loss of Rs. 40.27 crore for the half-year ended 30 September 1998 after providing Rs. 31.75 crore for NPAs. Provisional losses for 1998-99 are about Rs. 96 crore. This includes provisioning of Rs. 83 crore. Deposits will have to be repaid to the extent of Rs. 90 crore. This would entail a severe strain on the cash flow. 27. As on 31 March 1999, the bank had 26,584 employees. This included 9,231 officers, 13,350 clerks and 4,003 sub-staff. It also has 543 employees in its three overseas branches. About 57 per cent of the employees are in the age group of 41 to 50. 28. The bank needs officers skilled in credit appraisal and monitoring, NPA recovery, risk management and treasury. While the banks training facilities for its employees are on par with industry standards, it does not have a systematic database to track the skills of its employees. The lack of an effective placement policy, which matches organisational requirements with individual skills and objectives, underscores the need for skill upgradation. 29. The bank has attained 29.08 per cent branch computerisation in March 1999 and has targeted to increase this to 58 per cent by March 2000 and 70 per cent by December 2000. The bank currently has 25 ATMs and the target is to have 75 ATMs by March 2000 and 125 by March 2001. The bank has installed 16 VSATs and this will increase to 30 by March 2000 and 60 by March 2001. 30. The banks problems can be summarised as follows: a. The business efficiency factor i. Lower yields on advances and investments.

ii. Higher cost of funds. iii. Expenses disproportionate to income earning assets. iv. No growth in fee income. b. The structural factor i. A huge NPA portfolio. ii. Funding of losses by interest bearing funds. iii. Loss in subsidiaries. iv. Loss in overseas operations. c. The organisation factor i. Lack of direction in business strategy with regard to target customer segments. ii. Non-upgradation of skills to match changing needs. iii. Low morale and lack of will to take decisions. 31. The bank, in its projections provided to the sub-group, has covered only the period up to 2002. The banks projection is only up to the operating profit/ loss level and does not consider provisioning and net profit figures. The projection is only for domestic operation. It has not indicated any changes in the existing structure to attain the projection. While the bank feels that recapitalisation is needed to sustain customer confidence and attract good quality assets, it has not indicated the quantum/mode of recapitalisation required. 32. The bank expects some regulatory forbearance including reduction in CRR requirements to three per cent, favoured treatment for PSU and railway accounts, participation in State Bank of India/Financial Institution consortiums, higher allocation of food credit and favoured treatment for retailing of government securities. 33. The bank also expects to increase current and savings bank deposits from 32.87 to 36 per cent, extend working hours for cash transactions at totally computerised branches, mobilise deposits by extending consumer credit loans to professionals and others and extending telebanking facility and increasing ATMs. 34. For credit expansion, the bank proposes to focus on mid-sized trading borrowers, non-priority jewel loans, consumer credit loans and clean personal loans, build confidence at field level, relax pre-release audit without diluting safety of advance, reintroduce secured overdraft and review PLR to facilitate availing of limits in sanctioned accounts. 35. The bank expects to reduce NPA by delegating increased powers to field level functionaries including branch managers for compromise. Recovery monitoring cells will be put in place. Special monitoring officers for NPAs of Rs. 5 crore and above will be posted and recovery camps for small loans and rural credits held. All officers and staff in branches will be involved in the recovery process.

36. The bank estimates deposits to grow at 15 per cent, which appears optimistic. It expects credit to grow by 19.45 per cent and 18.70 per cent in the years 2000-01 and 2001-02 respectively. It also expects the yield on advances to be 14.50 per cent during the period. This is not supported by its past growth and inherent strengths and weaknesses. The banks lending rates are high and even if such a growth is realised, it will be extremely risky for the bank. 37. The banks estimation for fresh NPA generation and reduction in NPA are optimistic and not borne out by its past record. Its estimates in respect of growth in interest and non-interest income and non-salary non-interest expenditure are also optimistic. 38. Based on the sub-groups assessment of the capabilities of the bank, the banks business plan was modified. The assumptions and outcome of the possible scenarios are summarised below: Scenario Assumptions Present Value of Comments Recapitalisation (Zero coupon bonds) No recapitalisation Not a turnaround

Case I

Case II Case III Case IV

Case V

Business growth at 14% Employee expenses to grow at an average of 15% Case I + Business growth at 16% (instead of 14%) Case II + Partial wage freeze at 11% annual increase Case II + Wage freeze at 4% annual increase (to provide for DA) Case IV + Asset reconstruction company to take care of the NPAs (70% of the NPAs transferred at 50% of their gross value)

Rs. 2,855 crore Rs. 2,352 crore Rs. 1,831 crore

Not a turnaround Not a turnaround Operating profits in 2003 and net profits in 2004 The best case scenario.Difficult to achieve.

Rs. 1,933 crore

39. The turnaround initiatives for the bank can be broadly classified into three areas: structural, organisational and business strategies. The structural issues would include infusion of capital, closing down of subsidiaries and international operations, reduction of staff through VRS and hiving off NPAs into an ARC. The organisational issues would include having a chief executive with a long tenure and a deputy CEO or ED with a clear indication that he would take over as the CEO. The organisational structure would also need to be revamped structure to manage business and risks effectively. The business issues will have to cover upgradation of risk management systems, identification of business areas to be focused on, improving credit appraisal and risk management skills and removal of fear psychosis and improving the morale of the employees.

Annex 5 Sub-group report on UCO Bank Executive Summary 1. UCO Bank has a four tier organisational structure; Head Office, Zonal and Regional Offices and 1,790 branches of which 65 per cent are in the rural and semi-urban centres. 2. The bank has sponsored 11 RRBs, three each in West Bengal and Bihar, two each in Rajasthan and Orissa, and one in Madhya Pradesh. The accumulated losses of these RRBs aggregated Rs. 233.11 crore as at the end of March 1998. As on 30 September 1998, the total paid-up capital of the 11 RRBs was Rs. 10.87 crore of which UCO Bank contributed Rs. 3.85 crore. 3. UCO Bank has been continuously incurring losses since 1989-90. Some major factors which have contributed to the weak financial position of the bank are detailed as follows: High level of NPAs causing reduction in interest income and increase in provisioning, thereby reducing profitability Excess staff resulting in high staff expenses Lack of succession planning in senior management Low staff morale coupled with restrictive trade practices Lack of new product delivery Low level of computerisation, absence of MIS and poor housekeeping 4. Several studies were conducted in the past by various consultants (ICRA appointed by RBI, NIBM and Batliboi) to suggest measures for turnaround of the bank. The major recommendations of ICRA were a. Massive capital infusion of Rs. 375 crore.

b. Setting up of ARF for taking over NPA accounts aggregating Rs. 281 crore and recovery of NPAs through judiciously negotiated compromise, settlement and invocation of government guarantees. c. Cost reduction through wage freeze and downsizing through VRS.

d. Improving business through deposit growth to bring it on par with that of leading banks and better credit delivery through revamping of credit appraisal systems. e. Splitting the CMDs post into that of a non-executive Chairman and a Managing Director and addressing the problem of inadequate senior management due to serious gaps in succession. f. Cost reduction, winding up of overseas operations, improved customer service, housekeeping, rationalisation of branches, redeployment of excess manpower in deficit areas, recruiting professionals in merchant banking, MIS and strategic planning, etc.

5. Based on the recommendations of ICRA, the bank initiated measures for improving deposit mobilisation, recovery of NPAs, toning up of credit management system, improving housekeeping, etc. However, there were reservations on the strategy suggested on wage freeze, VRS and closure of overseas branches. Setting up of an ARF was not found to be feasible by the GOI/RBI. 6. At the instance of the Government, the bank drew up Strategic Revival Plan (SRP) covering the period 1997-98 to 1999-2000 for its turnaround. The restructuring plan aimed at achieving profitability targets in definitive time frames through improvement in key performance areas such as mobilisation of low cost deposits, credit management system, recovery of NPAs, house keeping and MIS, etc. The staff unions of the bank also signed an MOU assuring higher productivity and removal of restrictive practices. 7. The extent of success achieved under the SRP is far from significant. Certain measures such as setting up of Settlement Advisory Committee and recovery cells for recovery of NPAs were implemented. However, the bank was unable to achieve the important objectives of earning profit and reducing losses by 1998-99. There was no perceptible improvement by way of qualitative credit expansion. Instead, the bank took the safer route of investment in government paper. 8. The MOU with the Unions had only a limited impact on the cost front with certain sacrifices such as reduction of overtime and giving up of certain allowances. The other measures of cost control such as rationalisation of a few existing branches, embargo on new branches, curtailment of major capital expenditure, etc., do not have any major impact and the cost revenue ratio of the bank continued to exceed 100 per cent even by March 1998. The only significant result has been the closure of its London branch and merger of its two branches in Singapore. 9. In a belated recognition of the need for action, the committee of the Board of the bank set up to monitor progress under the revival plan had recommended (i) downsizing of the staff strength through VRS (7000 staff to be reduced in a phased manner in 3 years), (ii) further capital infusion of Rs. 250 crore by the Government, (iii) Mobilisation of Tier II capital, (iv) Non-implementation of wage settlement and (v) Closure/merger of loss making branches. The recommendations have not been endorsed by the representatives of the staff. There has been no serious follow-up measures to implement the recommendations. 10. During 1997-98, the bank posted an operating profit of Rs. 15 crore which increased to Rs. 38 crore in 1998-99. The bank could reduce its net loss from Rs. 96 crore in 1997-98 to Rs. 68 crore in 1998-99. If the interest income on recapitalisation bonds is excluded the bank would have incurred operating loss of Rs. 91 crore in 1997-98 and Rs. 157 crore in 1998-99. As at the end of March 1999, the banks accumulated losses stood at Rs. 1,804 crore. The bank received capital infusion from the government aggregating Rs. 2,257 crore till 1998-99. The bank had CRAR of 9.63 per cent as on 31 March 1999. 11. Despite the banks presence in most of the top 100 deposit/ advances centres, the banks deposit growth was only about 11 per cent and that of advances at 1-3 per cent during the period from 1994-95 to 1996-97. Consequently the CD ratio declined from 47

per cent in 1994-95 to 39 per cent in 1997-98, while the investment/deposit ratio increased from 44 per cent in 1994-95 to 52 per cent in 1997-98. Growth in domestic deposits and advances picked up in 1997-98 at 17 and 16 per cent respectively. However, the cost of deposits remained high at 8.5 percent. The deposit profile reveals that the eastern sector accounts for 39 per cent of the deposits. 12. The banks market share in advances declined considerably from 3.9 per cent in 1993-94 to 1.6 per cent in 1998-1999. Credit to priority sector and industry (medium and large) constitutes 37 and 35 per cent of the advance portfolio respectively. The highest share of the advance portfolio is in West Bengal and Maharashtra Zones. The banks increasing exposure to the steel and iron sector may be a cause for concern considering the poor situation of the industry. The credit management suffers from the following deficiencies resulting in high level of NPAs which aggregated Rs. 1,716 crore (23 per cent of gross advances) as at the end of March 1999. Delay in decision making due to four tier structural set-up. Lack of credit appraisal skills. Poor review and follow up. 13. The Zone-wise break-up of NPAs indicates the highest level of NPAs in West Bengal (Rs. 393 crore) followed by Maharashtra (Rs. 180 crore) and Southern Zone (Rs. 142 crore). The NPA slippage ratio was 6 per cent in 1998. The cumulative provisions constituted 41 per cent of the total NPAs as on 31 March 1999. Majority of the NPAs is in the doubtful/loss category. The SSI and agricultural category account for a major portion of NPAs. The recovery of NPAs has been tardy as bulk of NPAs is in the Rs. 25,000 to Rs. 25 lakh category with a large number of accounts. Cases filed with the Debt Recovery Tribunals amounted to Rs. 474 crore out of which the settlement was only Rs. 45 crore and the actual recovery, Rs. 14 crore. As at the end of March 1998, outstanding amount under government guaranteed accounts aggregated Rs. 90 crore. The bank is resorting to compromise for accelerating recovery of NPAs. Since July 1998, quarterly reporting of fresh generation of NPAs from each branch has been implemented. A scheme for awarding trophies to the best performing zones besides issuance of letters of reprimand to those officials who have exceeded 3 per cent level in fresh generation of NPAs has been introduced. 14. The investment portfolio of the bank comprises of high proportion of SLR and government securities, which have a relatively low yield. The banks secondary operations are not very significant as indicated in the low profit on sale of investments. There has been an increase in investments in PSU bonds and corporate debentures. Lack of clear focus, research and database and computerisation are the main constraints faced by the investment department. In the last three years, yield on investments improved marginally. 15. Loss making branches numbering 829 constituted 46 per cent of total branches. While the maximum number of loss making branches are in the rural areas (54 per cent), metro branches account for the highest quantum (36 per cent). West Bengal and Gujarat have the highest number of loss making branches. Under the prevalent Transfer Pricing mechanism adequate incentives have been given to both the deposit and advances

oriented branches with adequate disincentives built in for non-performing assets. There has been a substantial reduction in the number of loss making branches primarily on account of change effected in the Transfer Pricing mechanism with effect from April 1997. 16. Internal control and house keeping in the bank leave much to be desired. There is no centralised MIS in the bank. Books in various branches were not balanced for a considerable period. Control of the Head Office was not exercised over the Zonal Offices and Regional Offices as the various returns which were required to be submitted were not done in time and even when they were submitted, were incomplete and incorrect at times. There was inadequate follow-up from the Head Office to ensure timely submission as well. There were 23,874 unreconciled inter branch entries as on 31 March 1998 aggregating Rs. 217 crore. There were 13,627 unadjusted entries in clearing difference account aggregating Rs. 24 crore as on 31 March 1998. Further there were 40 branches where the books were not balanced even with crystallised difference for as many as three years as on 31 March 1998. 17. The bank has four overseas branches, two each in Singapore and Hong Kong. The banks London branch, which was making losses, was closed in 1998. Overseas branches earned a net profit of Rs. 22.61 crore during 1998-99. During 1998-99, an amount of Rs. 44 crore was remitted on account of loss incurred in closure of the London branch. 18. In the past, vacancies in the top managerial posts were unfilled for long duration. The age profile of the staff is adverse with 11 per cent of the staff above 55 years and 50 per cent of officers above 50 years. A second rung of officers needs to be developed to avert a succession crisis. 19. An analysis of profitability shows that income on investments contributes 48 per cent while the share of income on advances is lesser at 34 per cent. The contribution of fee based income to total income is not very significant at 5 per cent. 20. The bank has recently undertaken a restructuring exercise, which envisages a three-tier organisational structure by closure of the Zonal/ Regional Offices and establishment of five Local Head Offices to oversee the operations of about ten regions. Other measures taken by the bank are detailed under: Creation of post of General Manager (operations) to oversee the functioning of branches and large credit proposals to be sent to Head Office directly to quicken the process of decision making. Formation of Asset Liability Management Committee and MIS department. Focus on mid-market segment. Recovery of NPAs through recovery camps and compromise. Closure/merger of 34 loss making branches. Increased computerisation. Instilling confidence and reducing fear psychosis in the staff to take informed credit decisions. 21. The sub-group noted that the projected business plan envisaged net profit of Rs.

19 crore to be generated in the year 2001 which is expected to grow in the subsequent years up to 2004. The bank assumes capital infusion aggregating Rs. 2,614 crore to maintain minimum CAR of 9 per cent in 2000 and 10 per cent thereafter. The bank is not likely to record current median levels of minimum competitive efficiency even by 2003. It is pertinent to remember that by then, the efficiency parameters of the remaining public sector banks would have moved up further considerably. 22. The sub-group assessed the revised business plan targets consistent with the capability of the bank based on the data available on its past record and the industry scenario. The projected growth in deposits (15%) was reasonable while that of credit (2224%) was optimistic. Consequently, the assumptions behind the higher Net Interest Margin or growth in non-interest income of about 19 per cent (as against industry average of 12.7 per cent) were not realistic. The bank was also unlikely to reach projected levels of yield on investment (with the planned shift to credit portfolio and the future movements in interest rates. Likewise, the rapid reduction of NPAs to 5 per cent by year 2004 was out of line with the current levels of recovery performance. It was, clear that the business plan as projected by the bank would not be feasible even after the moderation factored in by the bank on account of the limitations of the bank to bring down the level of NPAs and to increase the advances while ensuring quality to comply with the proposed projection of NPAs. 23. The sub-group accordingly, drew up modified plans in three different scenarios. The scenarios involved estimating different growth levels in business parameters such as advances, deposits, return on investments, non-interest income as well as expected level of NPAs. The scenarios involved gradual reduction in the staff cost to industry level as well as bringing it down at one stroke. The estimate of the additional capital infusion requirement from the government would vary between Rs. 600 and Rs. 1,800 crore under the three different scenarios. After taking into account the likely shortfalls in attainment of targets, the sub-group observed that under all scenarios, the bank would require a minimum of four years to reach a reasonable level of net profit. An earlier turn around is, however, feasible if reduction of staff cost is attempted in one stroke to come to the level of industry median. Annex 6 Sub-group report on United Bank of India Executive Summary 1. United Bank of India has a three-tier organisational structure: Head Office, 33 Regional Offices and 1,333 branches. There is a separate Zonal Office to oversee the seven ROs in the North-east Region. The 1,167 branches in the Eastern and North-eastern regions account for 87 per cent of total branches. 2. The bank has lead bank responsibility in 33 districts. It is also convenor of the SLBC in the states of West Bengal, Manipur and Tripura. The bank has sponsored 11 RRBs, five in West Bengal, four in Assam and one each in Manipur and Tripura. The accumulated losses of these RRBs aggregated Rs. 417.44 crore as at the end of March 1998.

3. UBIs position has marginally improved over the last five years. There has been improvement in profitability and capital adequacy assisted by the regular capitalisation by GOI and income tax refund of Rs 111 crore. For the first time in five years, the bank registered a small profit of Rs. 9.62 crore during 1997-98. Bank has been deploying a larger quantum of incremental resources in zero risk government securities with small investments in corporate debentures. CD Ratio has accordingly come down. Net interest margin has improved due to the higher share of performing assets in the overall portfolio. Fee-based income avenues are weak in comparison to other banks. Cost income ratios and expense income ratios are high. 4. The management approach was cautious and conservative since the early nineties. No plan of action has been formulated and implemented with a view to achieve turnaround, may be as a consequence of the frequent changes at the helm. Short tenure and frequent changes of top management did not help the banks cause in pursuing a long term strategy for turnaround. 5. Employee cost accounts for 22 per cent of total income. Employee productivity ratio is also low at Rs. 12 lakh of business per employee. Average age profile of employees is above 45. Infrequent training and unresponsiveness to the same have created gaps in skill levels especially in specialised areas such as credit marketing, treasury, forex and IT. Transfer policy does not support specialisation. Employee motivation has been low. Practically no growth avenues are available for competent officers. Training of officers is not done on the basis of their needs. An officer attends a training programme as infrequently as once in 4-5 years. 6. Growth in credit has been slow during the last five years. Due to overpricing and inadequate services, it has been excluded from various consortiums. The bank lacks a comprehensive marketing strategy and follow-up action plan geared towards attracting and retaining corporate clients. The bank has therefore been deploying surplus resources in government securities. 7. Income from fee based services like remittances, foreign exchange business, guarantees and LCs have been very low due to a combination of reasons such as lack of captive clientele from credit, gaps in service quality, weak bank perception and inadequate marketing. 8. Poor asset quality: The historical focus of the bank in the eastern region and the inability to attract good credit quality clients has led to poor asset quality. 9. Deposit growth rate has been lower than the average for all scheduled commercial banks. UBIs cost of funds (as a percentage of average working funds) for 1998-99 at 8.3 per cent was higher than that for all SCBs. Current deposits constitute less than 10 per cent of the total deposits. The banks average deposits grew at a compounded annual growth rate of 15.4 per cent during 1995-99 as against an industry average of 17.1 per cent.

10. Credit generation has been slow since 1992. The CD ratio fell from 57.5 per cent in 1992 to 36.0 per cent in 1998. Slow credit growth can be attributed to the following reasons:
q q q q q q

Lack of focused marketing strategy. Focus on the economically weaker areas of east and north-east. Credit embargo by the central bank from 1992 to 1993 and reluctance of bank to take credit exposure due to weak capital position. Exclusion from consortiums lending to good quality clients. Low demand from existing clients. Introduction of credit substitutes and higher level of disintermediation.

11. While the bank monitors single risk exposure and industry exposures, as per RBIs norms, there is no system to monitor the credit risk profile of the overall portfolio, in order to plan future strategies and correct portfolio imbalances. 12.
q q

The main characteristics of the asset portfolio are: Weak quality of industrial advances: 21 per cent are non-performing and another 24 per cent appear vulnerable. Moderate industry-wise diversification of portfolio: high degree of exposure to the ferrous and non-ferrous metals sector. It also has a substantial exposure to engineering and tea processing industries. Relatively large single risk exposures: In view of capital erosion, some of the bigger advances which were within the single and group borrower limits are now outside such limits thereby exposing the bank to high risk. High level of NPAs in all forms of priority sector advances: 50 per cent of these advances are NPAs. age profile of NPA accounts is such that more than five years old cases account for 42 per cent in terms of number of accounts and 55 per cent in terms of amount.

q q

13. The yield on investments has increased to 11.95 per cent as at the end of March 1998 from 11.05 per cent at the end of the previous financial year. The yield is lower as compared to other public sector banks due to the higherproportion of low yielding recapitalisation bonds. About 7 per cent of the investments in corporate bonds (total portfolio: Rs 424.20 crore) is in the vulnerable category. Exit strategies have not been devised or resorted to, as the market is not liquid. 14. The banks non-interest income has been declining over the last three years and was only 0.55 per cent of its average total assets during 199798. Commissions on foreign exchange yielded around Rs. 5 crore during 199899 and has been virtually stagnant over the last three years. The impediments to

the banks efforts in increasing income from foreign exchange business are the following:
q q q q q q q

Low export credit at 5.2 per cent of net advances as against the minimum of 12 per cent stipulated by RBI. Absence of policy and guidelines for the conduct of foreign exchange business. Transfer policy does not support development of expertise in foreign exchange. Risk-averse attitude among management leading to banks clients not routing a proportionate share of forex transactions through the bank. Lack of adequate ongoing training and skills enhancement. Poor internal inspection and supervision of authorised dealing branches. Negligible trading profits due to insignificant proprietary trading, risk averse attitude, adverse age profile of dealers, low level of merchant turnover and consequent low levels of inter-bank turnover, and negligible/non-existent counterparty limits. The banks exchange profits were Rs.9.02 crore (1997-98).

15. According to UBIs transfer pricing mechanism, for the financial year 1997-98, 1,229 out of 1,333 branches were profitable despite poor financial condition of the bank as a whole. Out of the 104 loss-making branches, 81 are located in the eastern and northeastern regions. 16. Systems and housekeeping are two neglected areas. Less than 10 per cent of the banks branches are partially computerised and only a few large branches have been fully computerised. Low level of mechanisation due to opposition by labour unions and insufficient IT team to manage the implementation process. 17. Around 45 per cent of the total work force is in the age group of 45 per cent and above with around 10 per cent being 55 and above. Among officers, around 60 per cent are in the age group of 45 years and above. This has resulted in low mobility, unwillingness to take higher responsibilities and low receptivity to change. The skewed age profile along with infrequent promotions, weak image and performance of the bank and fear psychosis have gradually made employees demotivated and even indifferent to promotions. 18. A contribution analysis for the year ended March 1998 shows that advances provided negative contribution, primarily on account of the non-accrual of income and the provisioning required to be made for non-performing assets. However, investment provided a positive contribution, which has offset the negative contribution in credit business. This includes proceeds from sale of investments. The bank showed a net profit, after administrative and employee expenses, due to the extraordinary accrual of interest dues of Rs. 111 crore from the income tax department. The bank has a lower net interest margin as compared to other banks, which has led to its poor performance on the profitability front. 19. The banks capital adequacy is low in comparison to other banks despite capital infusion of Rs. 1,100 crore during the last five years. The Tier 1 capital coverage of net

NPAs is low, at around 77 per cent. External support is imperative since there is no contribution from earnings. There is also a need for further infusion to meet future provisioning requirements. 20. The following recommendations have been made to reduce the costs to the required levels: Wage freeze for a minimum of one wage settlement period (1997- 2002): this will save capital worth Rs. 356 crore over the five year period. The cost-income ratio will be reduced to 89 per cent. Reduction in manpower strength by 3,000 personnel during 1999- 2000: This measure in addition to wage freeze will reduce cost-income ratio to 81 per cent by 1999-2000. 21. Reduction in manpower should be by offering an attractive VRS targeted at the older personnel in each cadre. This constitutes around 14 per cent of the existing staff strength. The reduction in staff by 3,000 persons will lead to a reduction in staff expenses by around Rs. 42.25 crore in 1999-2000. The target category for VRS in officer cadre are scale 1 and scale 2 officers above the age of 50 numbering around 1,900. The target category in the clerical cadre is those above 45 years numbering around 5,600. The target category in the sub- staff cadre is those above 40 years numbering around 4,200. The VRS will have to be financed through government support as the bank is already short of capital and internal resources generation options do not appear adequate. Sale of branch network to finance VRS will affect future deposit growth. However, sale of a few branches in the non-core regions, where the bank does not have a competitive advantage may be considered. For instance, 10 of the 40 branches in the Southern region do not have a competitive advantage. 22. Transfer of doubtful and loss assets to an ARC will not only augment the banks income but also free managerial resources to focus on smaller value NPAs. This would depend on the following: Establishment of an ARC on an industry-wide basis, capitalised by external participants and not from the financial system. Legal reforms and improved legal infrastructure to enable faster resolution of cases. Specific legal powers for the ARC are warranted. Valuation of assets transferred on a case to case basis. 23. The bank should embark on an image building exercise by maintaining high visibility in its areas of operation on a sustained basis, through different media. This should be backed up by a clear action plan on rectifying the weaknesses that the bank currently faces. This will help remove the weak bank image and motivate the banks own employees. 24. The bank should follow a cautious strategy to credit growth, powered by selective addition of new clients, till internal systems of credit delivery and risk management are improved in line with the industry standards. The bank should establish separate corporate banking cells at each metro responsible for credit marketing and delivery. The

focus should be on meeting the needs of high value corporate customers (potential and existing), based on relationship manager concept, to ensure excellent service standards. Relationships with top clients should be handled out of these corporate banking cells to cut through layers and ensure faster response times, by having direct access to the top management / decision- making committees. 25. New areas of financing like infrastructure, services and software offer the bank with opportunity to sustain its credit growth and also diversify its portfolio of advances. The bank would need to evolve methodologies for appraisal, financing and risk mitigation, as these sectors are different in character from traditional sectors. Bank should contain or terminate direct lending to sub-sectors/ regions where experience has not been satisfactory. It should explore giving credit indirectly through institutions like NABARD/SIDBI, etc. where recovery of capital is guaranteed. 26. Portfolio credit quality is to be measured and tracked by adopting a suitable credit evaluation system. Risk and exposure profiles needs to be updated frequently. The bank should contain large exposure concentration in clients/ groups due to its weak net worth. It should enhance associated tracking and follow- up systems at the field level. Assistance of external credit evaluation expertise for particular sectors/corporates should be procured on a case to case basis to aid evaluation as well as improve response times. The bank should focus on diversifying business out of the eastern sector into areas where industrial activity and credit repayment culture are stronger. 27. Total branch mechanisation will be very crucial to improve efficiency and service. TBM of all high business branches and regions should be carried out on a high priority. Networking of these select branches with the Head Office will aid in improving housekeeping, service to clients and decision response times. 28. Export credit needs to be significantly improved through a combination of marketing and improved delivery of services and derive spin off benefits. The forex set-up needs a review in terms of its structure, synergy with credit function and adequacy of staff and skills. Specialists should be retained in this line to derive maximum return on investment in training. Infusion of external expertise in the form of experienced senior level specialist bankers in this area will be crucial. 29. High business potential locations such as Mumbai, Delhi and other metros should have well trained and updated personnel. Targets of these locations should be reestimated based on business potential. 30. Productivity needs to be enhanced by rationalising branches and relocating human resources. The bank has proposed that it will merge / relocate branches where necessary, open Sunday branches / morning branches / seven days a week branches, etc., identify and upgrade branches in metro an urban centres and provide service on part

with that of foreign / private sector banks, open branches in potential centres in different parts of the country in lieu of merger of some of its existing branches. Annual targets should be set for the above measures and followed diligently. 31. Priority sector norms for weak banks should be relaxed for a period of five years. UBIs priority sector portfolio has NPA levels in excess of 50 per cent and accounts for 60 per cent of its total NPAs. 32. It is expected that there is an additional capital requirement of Rs. 155 crore. This will enable the bank to meet the capital adequacy norm and also meet the capital required to finance the VRS. 33. Under the proposed restructuring plan and the assumptions made therein, the bank is expected to make profits from 2000-2001 onwards. However, it reaches minimum competitive efficiency levels on return on assets, only in 2003- 04. In 1999-2000, the bank makes a loss of Rs. 122 crore, on account of VRS payment which is assumed to be recognised in the year of incidence. Subsequent to VRS and the wage freeze, the cost to income ratio would come down to 81 per cent in 1998 and would continue to reduce further to 70 per cent at the end of the horizon. The employee cost to total income ratio comes down to 19.8 per cent in 1999-2000 and gradually reduces to 19 per cent by 200304. 34. These measures constitute an initial plan to correct the financial position of the bank. It is by no means sufficient to effect a complete turnaround. The bank will have to create its own strategies with regard to regional diversification, operations, human resources management, technology management, etc. so that the bank clearly does not regress back to its old position. Annex 7 List of persons met by the Working Group Sr. No. 1. 2. 3. 4. 5. 6. 7. 8. Name Mr. Eric D. Cruikshank Shri Tarun Das Shri V.V. Desai Mr. Martin Fish Shri D.N. Ghosh Shri Omkar Goswami Shri Rashid Jilani Shri Y.H. Malegam Designation Manager, International Finance Corporation Director General, Confederation of Indian Industry Economist, ICICI (then) CEO, Standard Chartered Bank Chairman, ICRA Ltd. Senior Consultant, Confederation of Indian Industry CMD, Punjab National Bank Chartered Accountant and Member, Board for Financial Supervision

9. 10.

Shri Sanjiv Minocha Shri M. Narasimham

11. 12. 13. 14. 15. 16. 17. 18. 19. 20.

Shri A.T. Pannir Selvam Shri Deepak S. Parekh Dr. Amrita Patel Prof. Mihir Rakshit Shri E. A. Reddy Shri S.S. Tarapore Shri S. Venkitaramanan Shri R. Viswanathan Shri N. Vittal Shri Prakash Yardi

Senior Investment Officer, International Finance Corporation Former Governor, Reserve Bank of India and Chairman, Administrative Staff College of India CMD, Union Bank of India Chairman, HDFC Ltd. Member, Board for Financial Supervision Economist Member, Board for Financial Supervision Former Deputy Governor, Reserve Bank of India Former Governor, Reserve Bank of India Former DMD, State Bank of India Chief Vigilance Commissioner Principal Investment Officer, International Finance Corporation

Government of India 1. 2. 3. 4. Dr. Vijay L. Kelkar (then) Finance Secretary Shri C.M. Vasudev (then) Special Secretary (Banking) Shri M. Damodaran Joint Secretary, Banking Division Shri Sudhir Shrivastava PS to Finance Minister

Reserve Bank of India 1. 2. 3. 4. 5. Dr. Bimal Jalan Governor Shri S.P. Talwar Deputy Governor Dr. Y.V. Reddy Deputy Governor Shri Jagdish Capoor Deputy Governor Shri G.P. Muniappan Executive Director

Organisations whose representatives met the Working Group 1. 2. 3. 4. 5. 6. 7. 8. 9. 10. 11. United Forum of Bank Unions All India Bank Employees Association All India Bank Officers Confederation National Confederation of Bank Employees All India Bank Officers Association Bank Employees Federation of India Indian National Bank Employees Federation Indian National Bank Officers Congress National Organisation of Bank Workers National Organisation of Bank Officers Federation of Indian Bank Employees Unions

12. 13. 14. 15. 16. 17. 18. 19. 20. 21. 22. 23. 24. 25. 26. 27.

All India Indian Bank Officers Association Indian Bank Officers Federation National Association of Indian Bank Officers All India Indian Bank Staff Union All India Federation of UCO Bank Officers All India UCO Bank Officers Federation UCO Bank Officers Congress All India UCO Bank Employees Federation UCO Bank Employees Association All India UCO Bank Employees Staff Federation United Bank of India Employees Association United Bank of India Employees Union United Bank of India Shramik Karmachari Samity United Bank of India Employees Congress United Bank Officers Association United Bank of India Officer Employees Association Annex 8 Select ratios for all Public Sector Banks Capital Adequacy Ratio March 1998 18.14 15.28 12.05 16.90 14.58 13.24 9.83 10.65 10.40 11.88 12.37 9.54 11.39 8.81 10.83 9.11 11.64 11.48 11.61 9.34 10.86 10.30 10.90 March 1999 14.35 14.10 13.30 13.20 12.51 12.47 12.35 12.26 11.88 11.14 11.02 10.96 10.94 10.79 10.65 10.55 10.38 10.27 10.23 10.15 10.09 10.02 9.76

A.

S.No. Name of the Bank 1. 2. 3. 4. 5. 6. 7. 8. 9. 10. 11. 12. 13. 14. 15. 16. 17. 18. 19. 20. 21. 22. 23. State Bank of Saurashtra Oriental Bank of Commerce Bank of Baroda Corporation Bank State Bank of India State Bank of Patiala State Bank of Indore State Bank of Bikaner & Jaipur Central Bank of India Dena Bank Andhra Bank Canara Bank Punjab & Sind Bank Punjab National Bank State Bank of Hyderabad Bank of India Allahabad Bank State Bank of Travancore State Bank of Mysore Indian Overseas Bank Union Bank of India Vijaya Bank Bank of Maharashtra

24. 25. 26. 27.

UCO Bank United Bank of India Syndicate Bank Indian Bank Minimum prescribed level

9.07 8.41 10.50 1.41 8.00

9.63 9.60 9.57 (-) 8.94 9.00

B. Coverage Ratio S.No. Name of the Bank 1. 2. 3. 4. 5. 6. 7. 8. 9. 10. 11. 12. 13. 14. 15. 16. 17. 18. 19. 20. 21. 22. 23. 24. 25. 26. 27. Corporation Bank Oriental Bank of Commerce State Bank of Saurashtra Andhra Bank State Bank of Patiala State Bank of India Bank of Baroda Canara Bank Syndicate Bank Bank of India Bank of Maharashtra Vijaya Bank Union Bank of India Dena Bank State Bank of Hyderabad State Bank of Bikaner & Jaipur Punjab National Bank State Bank of Indore Central Bank of India Indian Overseas Bank State Bank of Travancore Punjab & Sind Bank United Bank of India UCO Bank State Bank of Mysore Allahabad Bank Indian Bank Threshold rate March 1998 6.45 5.38 4.48 3.65 2.88 2.84 2.31 2.07 0.14 1.10 0.80 0.29 0.94 0.53 (-) 1.08 0.90 (-) 0.63 (-) 1.00 (-) 1.24 (-) 0.24 (-) 1.68 (-) 1.12 (-) 1.36 (-) 2.19 (-) 1.52 (-) 2.32 (-) 10.42 0.50 March 1999 5.68 4.70 3.19 2.59 2.41 2.02 1.88 1.85 0.88 0.79 0.66 0.65 0.51 0.30 0.21 0.09 (-) 0.28 (-) 0.39 (-) 0.56 (-) 0.81 (-) 0.85 (-) 0.93 (-) 1.03 (-) 1.18 (-) 1.43 (-) 1.48 (-) 12.13 0.50

C. Return on Assets S.No. Name of the Bank 1. 2. 3. Corporation Bank Oriental Bank of Commerce State Bank of Patiala 1997-98 1.49 1.40 1.48 1998-99 1.43 1.20 0.99

4. 5. 6. 7. 8. 9. 10. 11. 12. 13. 14. 15. 16. 17. 18. 19. 20. 21. 22. 23. 24. 25. 26. 27.

State Bank of Bikaner & Jaipur 1.08 0.98 State Bank of Hyderabad 0.91 0.85 Bank of Baroda 1.01 0.81 Punjab National Bank 1.20 0.80 Andhra Bank 0.84 0.78 Allahabad Bank 0.85 0.77 Dena Bank 0.86 0.75 Syndicate Bank 0.45 0.71 State Bank of Indore 0.68 0.63 Punjab & Sind Bank 0.76 0.58 Union Bank of India 0.97 0.51 State Bank of Mysore 0.86 0.49 Canara Bank 0.47 0.47 State Bank of India 1.04 0.46 Bank of Maharashtra 0.55 0.43 Central Bank of India 0.61 0.43 State Bank of Travancore 0.69 0.40 Bank of India 0.79 0.40 State Bank of Saurashtra 2.32 0.38 Vijaya Bank 0.26 0.28 Indian Overseas Bank 0.53 0.23 United Bank of India 0.07 0.09 UCO Bank (-) 0.57 (-) 0.36 Indian Bank (-) 1.77 (-) 4.26 Median @ 0.86 0.61 @ Median of all banks excluding Indian Bank, UCO Bank and United Bank of India. D. Net Interest Margin S.No. Name of the Bank 1997-98 3.86 3.94 3.25 3.61 3.68 3.63 3.64 2.49 3.68 3.22 3.38 3.00 2.91 3.48 1998-99 3.92 3.58 3.57 3.53 3.53 3.49 3.29 3.24 3.23 3.12 3.10 3.02 3.01 2.97

1. 2. 3. 4. 5. 6. 7. 8. 9. 10. 11. 12. 13. 14.

State Bank of Indore State Bank of Mysore Punjab National Bank State Bank of Hyderabad State Bank of Patiala State Bank of Saurashtra Bank of Maharashtra Canara Bank State Bank of Bikaner & Jaipur Central Bank of India Oriental Bank of Commerce Syndicate Bank Bank of Baroda Dena Bank

15. 16. 17. 18. 19. 20. 21. 22. 23. 24. 25. 26. 27.

Vijaya Bank 2.86 Andhra Bank 3.46 Allahabad Bank 2.82 State Bank of India 3.01 Union Bank of India 3.17 Bank of India 2.77 Corporation Bank 3.46 Punjab & Sind Bank 2.77 UCO Bank 2.14 Indian Overseas Bank 2.31 State Bank of Travancore 2.94 United Bank of India 2.22 Indian Bank 0.65 Median @ 3.24 @ Median of all banks excluding Indian Bank, UCO Bank and United Bank of India. E. Ratio of operating profit to average working funds S.No. Name of the Bank 1997-98 2.37 2.48 2.85 2.60 3.23 1.74 1.95 2.12 2.00 2.50 2.70 1.86 2.55 1.96 1.65 1.61 2.06 1.30 0.81 1.46 1.22 1.29 0.76 0.75 1.30

2.94 2.91 2.82 2.72 2.66 2.61 2.52 2.38 2.36 2.31 2.18 1.95 1.08 3.02

1998-99 2.50 2.34 2.30 2.30 2.28 2.17 1.95 1.91 1.85 1.79 1.79 1.63 1.59 1.55 1.42 1.41 1.30 1.24 1.22 1.13 0.95 0.89 0.89 0.59 0.30

1. 2. 3. 4. 5. 6. 7. 8. 9. 10. 11. 12. 13. 14. 15. 16. 17. 18. 19. 20. 21. 22. 23. 24. 25.

State Bank of Indore State Bank of Patiala State Bank of Hyderabad Oriental Bank of Commerce Corporation Bank Canara Bank Bank of Baroda State Bank of Saurashtra Punjab National Bank State Bank of Bikaner & Jaipur State Bank of Mysore Andhra Bank Dena Bank State Bank of India Allahabad Bank Bank of India State Bank of Travancore Bank of Maharashtra Vijaya Bank Union Bank of India Punjab & Sind Bank Central Bank of India Syndicate Bank Indian Overseas Bank United Bank of India

26. 27.

UCO Bank 0.09 0.21 Indian Bank (-) 1.23 (-) 0.89 Median @ 1.96 1.61 @ Median of all banks excluding Indian Bank, UCO Bank and United Bank of India. F. Ratio of cost to income S.No. Name of the Bank 1997-98 1998-99

1. 2. 3. 4. 5. 6. 7. 8. 9. 10. 11. 12. 13. 14. 15. 16. 17. 18. 19. 20. 21. 22. 23. 24. 25. 26. 27.

Corporation Bank 43.12 46.94 Oriental Bank of Commerce 47.11 49.38 State Bank of Patiala 53.99 50.70 Bank of Baroda 57.05 56.07 Canara Bank 60.03 56.26 State Bank of Hyderabad 48.34 58.36 State Bank of Indore 60.56 59.54 State Bank of Saurashtra 57.70 60.99 State Bank of Travancore 52.05 61.51 Punjab National Bank 58.49 62.62 State Bank of India 57.39 63.08 Dena Bank 55.20 63.61 Bank of India 62.61 64.46 Allahabad Bank 64.91 66.60 State Bank of Mysore 61.36 67.13 State Bank of Bikaner & Jaipur 58.89 67.18 Andhra Bank 63.66 67.62 Union Bank of India 65.88 71.67 Vijaya Bank 81.36 72.76 Bank of Maharashtra 73.36 73.42 Punjab & Sind Bank 71.65 74.86 Central Bank of India 72.09 78.61 Syndicate Bank 82.56 80.05 Indian Overseas Bank 78.00 82.49 UCO Bank 97.28 93.94 United Bank of India 87.50 97.61 Indian Bank 166.85 141.22 Median @ 60.30 64.04 @ Median of all banks excluding Indian Bank, UCO Bank and United Bank of India. G. Ratio of staff cost to NII + all other income S.No. Name of the Bank 1. Corporation Bank 1997-98 24.20 1998-99 28.61

2. 3. 4. 5. 6. 7. 8. 9. 10. 11. 12. 13. 14. 15. 16. 17. 18. 19. 20. 21. 22. 23. 24. 25. 26. 27.

Oriental Bank of Commerce 28.99 28.65 State Bank of Patiala 39.94 36.96 Bank of Baroda 39.35 39.27 Canara Bank 41.07 40.20 State Bank of Indore 41.37 42.02 State Bank of Hyderabad 35.39 42.70 State Bank of Travancore 36.35 44.33 State Bank of India 43.25 44.37 State Bank of Saurashtra 44.16 45.87 Dena Bank 40.08 46.41 Bank of India 41.32 46.57 Allahabad Bank 42.09 46.59 Union Bank of India 42.53 46.99 Punjab National Bank 45.16 48.65 Andhra Bank 46.42 49.60 State Bank of Bikaner & Jaipur 45.03 50.83 State Bank of Mysore 47.12 51.31 Vijaya Bank 58.65 51.68 Punjab & Sind Bank 51.26 51.85 Bank of Maharashtra 57.05 59.39 Central Bank of India 55.21 59.46 Indian Overseas Bank 58.18 62.28 Syndicate Bank 64.86 63.20 UCO Bank 80.19 76.37 United Bank of India 72.23 80.60 Indian Bank 124.86 107.79 Median @ 42.89 46.58 @ Median of all banks excluding Indian Bank, UCO Bank and United Bank of India. Annex 9 Market share of Public Sector Banks
Name of the Bank 1. State Bank of India Interest Income Non-int. income Total income Branches 1996-97 1997-98 1996-97 1997-98 1996-97 1997-98 1997 1998 13,991 14,968 3,106 2,605 17,097 17,573 8,888 8,925 (20.3) (20.9) (30.0) (22.3) (21.5) (21.1) (17.9) (17.6) 737 851 128 163 865 1,013 764 767 (1.1) 970 (1.4) 378 (0.6) 568 (0.8) 906 (1.3) 486 (0.7) (1.2) 1,035 (1.4) 407 (0.6) 610 (0.9) 940 (1.3) 503 (0.7) (1.2) 146 (1.4) 53 (0.5) 84 (0.8) 94 (0.9) 80 (0.8) (1.4) 170 (1.5) 73 (0.6) 104 (0.9) 98 (0.8) 93 (0.8) (1.1) 1117 (1.4) 431 (0.5) 651 (0.8) 1,000 (1.3) 566 (0.7) (1.2) 1,205 (1.5) 480 (0.6) 714 (0.9) 1,038 (1.3) 596 (0.7) (1.5) 800 (1.6) 372 (0.8) 557 (1.1) 699 (1.4) 380 (0.8) (1.5) 832 (1.6) 379 (0.8) 562 (1.1) 707 (1.4) 384 (0.8)

2. State Bank of Bikaner and Jaipur 3. State Bank of Hyderabad 4. State Bank of Indore 5. State Bank of Mysore 6. State Bank of Patiala 7. State Bank of Saurashtra

8. State Bank of Travancore 9. Allahabad Bank 10.Andhra Bank 11.Bank of Baroda 12.Bank of India 13.Bank of Maharashtra 14.Canara Bank

909 (1.3) 1,278 (1.9) 789 (1.1) 3,417 (5.0) 3,057 (4.4) 864 (1.3) 3,418 (5.0)

982 (1.4) 1,405 (2.0) 916 (1.3) 3,760 (5.3) 3,434 (4.8) 991 (1.4) 3,766 5.3)

124 (1.2) 178 (1.7) 95 (0.9) 384 (3.7) 354 (3.4) 85 (0.8) 450 (4.3)

149 (1.3) 217 (1.9) 117 (1.0) 458 (3.9) 423 (3.6) 100 (0.9) 583 (5.0)

1,033 (1.3) 1,456 (1.8) 883 (1.1) 3,801 (4.8) 3,410 (4.3) 949 (1.2) 3,868 (4.9)

1,131 (1.4) 1,621 (2.0) 1,033 (1.2) 4,218 (5.1) 3,857 (4.6) 1,091 (1.3) 4,349 (5.2)

654 (1.3) 1,863 (3.7) 978 (2.0) 2,493 (5.0) 2,475 (5.0) 1,147 (2.3) 2,262 (4.5)

660 (1.3) 1,875 (3.7) 974 (1.9) 2,493 (4.9) 2,495 (4.9) 1,162 (2.3) 2,312 (4.6)

Market share of Public Sector Banks

Interest Income Non-int. income Total income 1996-97 1997-98 1996-97 1997-98 1996-97 1997-98 15.Central Bank of India 2,530 2,821 305 364 2,836 3,184 (3.7) (3.9) (2.9) (3.1) (3.6) (3.8) 16. Corporation Bank 828 1,036 112 144 940 1,180 (1.2) (1.5) (1.1) (1.2) (1.2) (1.4) 17. Dena Bank 1,022 1,228 119 184 1,141 1,413 (1.5) (1.7) (1.2) (1.6) (1.4) (1.7) 18. Indian Bank 1,435 1,342 212 186 1,647 1,528 (2.1) (1.9) (2.1) (1.6) (2.1) (1.8) 19. Indian Overseas Bank 1,683 1,826 187 215 1,869 2,042 (2.4) (2.6) (1.8) (1.8) (2.4) (2.5) 20. Oriental Bank of 1,269 1,471 104 138 1,374 1,610 Commerce (1.8) (2.1) (1.0) (1.2) (1.7) (1.9) 21. Punjab & Sind Bank 732 845 88 115 820 960 (1.1) (1.2) (0.9) (1.0) (1.0) (1.2) 22. Punjab National Bank 3,787 4,237 421 681 4,209 4,918 (5.5) (5.9) (4.1) (5.8) (5.3) (5.9) 23. Syndicate Bank 1,523 1,583 159 219 1,682 1,802 (2.2) (2.2) (1.5) (1.9) (2.1) (2.2) 24. UCO Bank 1,148 1,293 106 175 1,254 1,468 (1.7) (1.8) (1.0) (1.5) (1.6) (1.8) 25. Union Bank of India 2,302 2,497 199 214 2,501 2,712 (3.3) (3.5) (1.9) (1.8) (3.2) (3.3) 26. United Bank of India 1,007 1,342 97 141 1,104 1,482 (1.5) (1.9) (0.9) (1.2) (1.4) (1.8) 27. Vijaya Bank 732 809 64 82 796 892 (1.1) (1.1) (0.6) (0.7) (1.0) (1.1) Total for PSBs 51,767 56,898 7,533 8,212 59,300 65,110 (74.9) (79.4) (72.7) (70.3) (74.6) (78.1) Total for all Banks 69,102 71,644 10,361 11,680 79,463 83,324 (100) (100) (100) (100) (100) (100) Note: Figures in brackets indicate percentage to total for all banks. Name of the Bank Branches 1997 1998 3,087 3,088 (6.2) (6.1) 507 581 (1.0) (1.2) 1,143 1,156 (2.3) (2.3) 1,487 1,494 (3.0) (2.9) 1,371 1,380 (3.0) (2.7) 755 841 (1.5) (1.7) 704 711 (1.4) (1.4) 3,765 3,893 (7.6) (7.7) 1,611 1,627 (3.2) (3.2) 1,803 1,802 (3.6) (3.6) 2,030 2,087 (4.1) (4.1) 1,333 1,333 (2.7) (2.6) 835 835 (1.7) (1.7) 44,763 45,355 (89.9) (89.4) 49,771 50,743 (100) (100)

Annex 10 Gross NPA Movement Movement in Indian Bank UCO Bank (Rs. crore) United Bank of

Gross NPA As on 31 March 1996 Reduction during 1996-97 Addition during 1996-97 As on 31 March 1997 Reduction during 1997-98 Addition during 1997-98 As on 31 March 1998 Reduction during 1998-99 Additions during 1998-99 As on 31 March 1999 3,140 482 645 3,303 347 472 3,428 164 445 3,709 1,840 354 387 1,873 371 278 1,780 327 263 1,716

India 1,401 167 164 1,398 97 150 1,451 101 199 1,549

Name of the Bank

Annex 11 Operating Expenses to NII and Other Income Operating Expenses to NII & Other income 1996-97 1997-98 1998-99 140.91 116.41 122.38 63.20 166.85 97.28 87.50 61.36 141.22 93.94 97.61 66.60

Indian Bank UCO Bank United Bank of India Median for PSBs

Annex 12 Staff cost to operating expenses Sr.No. Name of the Bank 1997-98 Oriental Bank of Commerce 61.54 1. Corporation Bank 56.11 2. Union Bank of India 64.55 3. Punjab & Sind Bank 71.55 4. Allahabad Bank 64.84 5. Bank of Baroda 68.98 6. State Bank of India 75.36 7. State Bank of Indore 68.31 8. Vijaya Bank 72.09 9. Canara Bank 68.42 10. State Bank of Travancore 69.83 11. Bank of India 65.99 12. State Bank of Patiala 73.96 13.

1998-99 58.03 60.94 65.56 69.27 69.95 70.03 70.34 70.57 71.03 71.46 72.07 72.24 72.90

Dena Bank 72.61 72.96 State Bank of Hyderabad 73.21 73.16 Andhra Bank 72.92 73.35 State Bank of Saurashtra 76.53 75.20 Indian Overseas Bank 74.59 75.50 Central Bank of India 76.58 75.63 State Bank of Bikaner & Jaipur 76.46 75.66 Indian Bank 74.83 76.33 State Bank of Mysore 76.79 76.43 Punjab National Bank 77.21 77.68 Syndicate Bank 78.56 78.96 Bank of Maharashtra 77.77 80.89 UCO Bank 82.43 81.29 United Bank of India 82.55 82.57 Median @ 72.77 72.57 @ Median of all banks excluding Indian Bank, UCO Bank and United Bank of India. 14. 15. 16. 17. 18. 19. 20. 21. 22. 23. 24. 25. 26. 27. Annex 13 Ratio of assets to employees (March 1998) (Amt. in Rs. crore) Sr.No. Name of the Bank Total Total Asset to assets staff staff ratio 1. 2. 3. 4. 5. 6. 7. 8. 9. 10. 11. 12. 13. 14. 15. 16. 17. 18. 19. 20. 21. Corporation Bank Oriental Bank of Commerce Bank of Baroda Bank of India Union Bank of India Dena Bank Canara Bank Indian Overseas Bank State Bank of India State Bank of Hyderabad State Bank of Patiala Punjab & Sind Bank Indian Bank State Bank of Travancore Allahabad Bank Vijaya Bank State Bank of Saurashtra United Bank of India Bank of Maharashtra Andhra Bank Central Bank of India 11,214 14,782 45,841 46,338 25,753 12,264 43,112 21,432 1,79,673 10,618 9,641 9,031 19,454 9,133 15,153 9,440 5,204 14,389 10,656 9,231 30,519 9,615 14,238 45,935 52,518 30,901 15,109 54,703 28,347 2,39,649 14,269 13,108 12,167 26,994 13,049 22,606 14,138 7,993 22,041 16,596 14,936 49,702 1.17 1.04 1.00 0.88 0.83 0.81 0.79 0.76 0.75 0.74 0.74 0.74 0.72 0.70 0.67 0.67 0.65 0.65 0.64 0.62 0.61

State Bank of Indore 4,093 6,831 0.60 Punjab National Bank 39,768 66,599 0.60 State Bank of Bikaner & Jaipur 8,523 15,046 0.57 UCO Bank 18,586 32,830 0.57 Syndicate Bank 19,476 36,266 0.54 State Bank of Mysore 5,863 11,217 0.52 Median @ 0.72 @ Median of all banks excluding Indian Bank, UCO Bank and United Bank of India. 22. 23. 24. 25. 26. 27. Annex 14 Staff cost to total income Sr.No. 1. 2. 3. 4. 5. 6. 7. 8. 9. 10. 11. 12. 13. 14. 15. 16. 17. 18. 19. 20. 21. 22. 23. 24. 25. 26. 27. Name of the Bank 1997-98 1998-99 Oriental Bank of Commerce 11.59 10.59 Corporation Bank 11.00 10.61 State Bank of Travancore 13.40 14.79 Bank of Baroda 15.67 15.65 Union Bank of India 16.06 16.42 Canara Bank 15.60 16.54 State Bank of Patiala 17.41 16.56 Dena Bank 17.48 16.74 Punjab & Sind Bank 18.86 17.22 Bank of India 17.06 17.89 Allahabad Bank 16.79 18.07 State Bank of India 19.03 18.52 State Bank of Hyderabad 16.28 19.76 Vijaya Bank 22.50 19.87 Indian Overseas Bank 18.62 19.95 Andhra Bank 19.21 19.98 State Bank of Indore 19.88 20.40 State Bank of Saurashtra 20.92 20.83 Punjab National Bank 18.83 21.41 United Bank of India 22.67 22.26 State Bank of Bikaner & Jaipur 21.17 22.27 Central Bank of India 22.40 22.89 State Bank of Mysore 21.78 22.99 Indian Bank 23.48 23.40 Bank of Maharashtra 24.52 24.31 Syndicate Bank 26.31 25.00 UCO Bank 27.07 25.74 Median @ 18.73 19.14 @ Median of all banks excluding Indian Bank, UCO Bank and United Bank of India. Annex 15 Structure of proposed NPA transfer mechanism

FRA: Independent agency set up under separate Act, government owned, approves and monitors bank-specific restructuring programmes, owns ARF, and appoints AMCs. ARF: Government-owned (through FRA), profit-oriented, buys loans from weak banks against bonds at negotiated prices, recovers/sells loans, limited life span as for FRA. AMC: Independent, private sector entity or existing Fund Manager, miniority government holding, manages ARF, staffed with top class professionals, incentive-driven.