If anything, this was a decision that has come to typify this government: don't take the hard decisions when faced with any political opposition. According to the decision, while the government is willing to reduce its stake in public sector banks to 33 per cent, no other shareholder will be allowed to buy more than 1 per cent of a bank. The government shall also continue to appoint bank chairmen, executive directors and directors on their boards. "This is a half measure which doesn't change things much," says Rohit Kumar, head, credit risk practice, at icra Advisory Services. The very next day, the All-India Bank Employees' Association (aibea) said they would go on indefinite strike (which will bring banking across the country to a virtual halt) when the bill to introduce changes in the Banking Companies (Acquisitions and Transfer of Undertakings) Act is introduced in Parliament this winter session. Says aibea assistant general secretary Kamal Bhattacharyya: "The main objective of this decision is to change the character of public sector banks." And though public sector bank stocks rallied initially, they came tumbling down—to their already poor valuations—soon after.
Just why did the government take this decision and how have they managed to spoil things for everyone? To ensure that Indian banks stay healthy, the Reserve Bank of India (rbi) mandates certain rules. One of them is that they must maintain a capital adequacy at least equal to 9 per cent of their risk-weighted assets. In other words, if a bank has lent Rs 100, it must have a capital base of at least Rs 9. And up to Rs 6 of this capital can be in the form of plain equity and free reserves, which is known as Tier 1 capital, while another 50 per cent of Tier 1, i.e. Rs 3, can be Tier 2 capital, made up of revaluation reserves and subordinated debt. To further increase safety of Indian banks, the rbi intends to increase capital adequacy to 10 per cent in the future. This is the level at which most good foreign banks operate. In fact, if the capital adequacy of a bank falls below 8 per cent, it is not allowed to perform correspondent banking operations and its Letters of Credit are not accepted internationally.