A run for your bank

Indian Express, 16 September 2004

Finance Minister P Chidambaram has announced that the Government will facilitate the merger of banks by changing the Income-Tax Act. This will be done by an amendment to the Income Tax Act. The rule in question is Section 72-A of the Income Tax Act. This Section deals with how losses may be set off against tax liabilities when a loss making firm is taken over. If the amendment goes through, it will give one more channel for taxpayers to pay for failed banks. The amalgamation of another sick Global Trust Bank with a healthy PSU bank like the Oriental Bank of Commerce will then be one more case of taxpayers paying for RBI’s weak banking regulation.

The first job of a banking regulator is to enforce sound standards for risk management. The best regulations will, however, not prevent some banks from going bust. Hence, the second job of a banking regulator is to force closure of a weak bank while it is still solvent. In this case, liquidation can take place in an orderly manner, and the only ones who get hurt are the shareholders of the weak bank.

An incompetent banking regulator fails on one or both of these requirements. Our banking regulator fails on both. RBI’s rules about banking regulation are riddled with analytical mistakes, where risk is not being measured and controlled correctly. In addition, RBI has always failed to detect and close down failed banks in time.

When the banking regulator fails, there is a choice in the allocation of pain, between depositors and taxpayers. Life is easy for a banking regulator in a country like India, where the government owns banks, since it becomes easy to inflict pain upon taxpayers. The taxpayer is being made to pay for the failure of GTB in two ways. First, under the amended Income Tax rule, GTB’s net losses of Rs 812 crore in 2003-04 and Rs 273 crore in 2002-03 will be set off on the OBC balancesheet. OBC will then pay less tax to the government. The government will get lower revenues from the banking sector as a result of the amalgamation. There will be no entry in the Budget because no expenditure item will be shown. But it will still be a subsidy from the government.

PSU banks with
zero net NPAs
Second, the government is paying through a hit on its balancesheet. On July 21, 2004, five days before the amalgamation of GTB with OBC was announced, the market cap of OBC stood at Rs 5008 crore. Four weeks later, the market cap of OBC had fallen to Rs 4481 crore. Thus, a hit of Rs 527 crore has been taken by the shareholders of OBC. The biggest shareholder in OBC is the Government of India. As the owner of 66.5 per cent of OBC, the government took a hit of Rs 350 crore. When we take into account the movement of Nifty over this same period, the more correct estimate of the loss of OBC shareholders works out to Rs 572 crore, of which GOI has borne Rs 380 crore. This hit is hidden from the taxpayer because, unlike in the case of a company, the government does not have a transparent balancesheet. Did the OBC board takes into account the interests of its shareholders when it decided to merge with GTB?

Are more bailouts in the offing? Does the RBI want the Income Tax Act amended merely to pay off OBC for taking on Rs 916 crore (as of March 31, 2003), of NPAs of GTB? Or, is the stage being set for making the taxpayer pay more for future lapses in banking regulation? There are a number of public sector banks who could be made victims for future forced mergers, to swallow failed banks. So, for example, the Indian Overseas Bank, the Union Bank of India, Bank of Baroda or Allahabad Bank could be the next victims. These banks could be ‘persuaded’ to take on failed banks with large NPAs because they will then be able to get tax rebates under Section 72 of the Income Tax Act, and therefore get the branch network and depositor base of the failed bank for free. Taxpayers, who are paying the bill, will be no wiser. The RBI will look wise and noble, having engineered a costless merger and having ‘‘saved depositors from losses.’’ Shareholders of healthy PSUs should worry about the hit they may have to take because of this move.

Ila Patnaik