The financial sector assessment report, prepared by the Reserve Bank of India (RBI) and the Central Government, has favoured the merger of public sector banks (PSBs) having a government holding bordering on 51 per cent with those having a much higher state-holding to ensure that their business growth does not suffer due to capital constraints.

If the government is not able to contribute its share of the capital needed for the growth of the public sector banking system, it will need to reduce its share holding below 51 per cent. This requires legislative changes, the report, which was released on Monday, said.

However, pending enactments of enabling legislation to reduce majority ownership, and keeping in mind the synergies, one option for the government could be to consider amalgamating banks, it added. It emphasised that such mergers should be considered only when there was positive synergy and complementarity in the regional spread among the banks proposed to be amalgamated.

The report indicated that PSBs would need additional capital to meet Basel II norms and maintain an asset growth for the overall projected growth of the economy at 8 per cent and consequent growth of risk-weighted assets (RWAs).

This has the potential to further aggravate a growing apprehension that public sector banks growth could be constrained in relation to other players.

The extent of additional capital required from the government is expected to be manageable, provided the RWAs grow by within 25 per cent annually and total cost of recapitalisation would be lower than in most other countries.

The government has already announced plans to infuse capital worth Rs 20,000 crore over two years in public sector banks to maintain a comfortable capital adequacy ratio of 12 per cent. Some of the banks, including Central Bank of India and Vijaya Bank, have already received the first tranche of capital. Referring to monitoring of state-owned banks, the report said any suggestion that the government must exit its monitoring function of these entities and leave governance entirely to a duly-constituted board was unrealistic in the present environment.

Such a move might be undesirable as well. A reduction in the governments majority shareholding would also enable the public sector banks to retain and attract talent as, in that case, their incentive structure would not be limited by the government pay structure.