State-run banks should be freed of constraints: Raghuram Rajan.

New Delhi: Public sector banks might perform better if they are freed from some of the constraints they operate under but such freedom typically requires distance from the government, says former Reserve Bank of India governor Raghuram Rajan.

He is also of the view that there is no guarantee that privatisation will be a panacea. Much of the discussion on privatisation, he says, seems to make assumptions based on ideological positions.

"Certainly, if public sector banks are freed from some of the constraints they operate under (such as paying above the private sector for low-skilled jobs and paying below the private sector for senior management positions, having to respond to government diktats on strategy or mandates, or operating under the threat of CVC/CBI scrutiny) they might perform far better," he says.

However, Rajan feels that such freedom typically requires distance from the government. "So long as they are majority-owned by the government, they may not get that distance."

Some private banks, according to him, have been poorly governed.

"Instead, we need to recognise that ownership is just one contributor to governance and look at pragmatic ways to improve governance across the board. There certainly is a case to experiment by privatising one or two mid-sized public sector banks and reducing the government stake below 50 per cent for a couple of others, while working on governance reforms for the rest," Rajan says.

In this case, "rather than continuing a never-ending theoretical debate, we will then actually have some evidence to go on. Some political compromises will be needed to allow the process to go through, but so long as the newly privatised banks are not totally hamstrung in their operational flexibility as a result of these compromises, this will be an experiment worth undertaking", he argues.

Rajan has put forth these views in a book titled "What the Economy Needs Now" which he has edited along with fellow economists Abhijit Banerjee, Gita Gopinath and Mihir S Sharma.

Agriculture, according to Rajan, needs serious attention but not through loan waivers as such measures only vitiate the credit culture.

He lists lending targets and compulsory loan waivers among the more dangerous mandates.

"Uncompensated government mandates have been imposed on public sector banks for a long time. This is lazy government - if an action is worth doing it, it should be paid for out of budgetary resources. Mandates also are against the interests of minority shareholders in public sector banks," he writes in the book, published by Juggernaut.

According to Rajan, government-imposed credit targets are often achieved by abandoning appropriate due diligence, creating the environment for future NPAs.

"Loan waivers, as the RBI has repeatedly argued, vitiate the credit culture and stress the budgets of the waiving state of central government. They are poorly targeted, and eventually reduce the flow of credit," he writes in the essay "Banking Reforms".

"Agriculture needs serious attention, but not through loan waivers. An all-party agreement to this effect would be in the nation's interest."

Rajan also feels that the banking system is overburdened with non-performing loans. "This means that they find it difficult to grow their new lending to industry, and growth suffers."

He suggests that the government should keep its banks well capitalised, conditional on improvements in governance and management efficiency.

"This is simply good accounting practice, for it prevents the government from building up contingent liabilities on bank balance sheets that a future government will have to pay for," he writes.