OREANDA-NEWS. A seven-part plan to reform and inject INR700bn into India's state-owned banks could be a significant step towards increased transparency, better governance and greater accountability for the sector, says Fitch Ratings. The measures aim to address critical aspects of public banks' day-to-day functioning, and will have positive effects for credit as they are implemented over the medium term.

The impetus for reforming public banks is high in light of growing competition and large capital shortfalls. In line with broader sector liberalisation, the central bank gave in-principal approval on 19 August to 11 businesses to launch a new type of mobile-focused payments bank. These new banks will be allowed to take deposits up to INR100,000 (USD1,530) and transfer funds. Their focus on smaller deposit holders and mobile banking will add to competitive pressures for public banks, and could potentially pose risks to their market share over the long term.

The most notable elements of the reform plan, which was released by the Ministry of Finance on 14 August, address issues pertaining to management and governance at public banks. In particular, the reforms to make leadership positions at the large state banks eligible to candidates from the private sector, and to establish a dedicated Bank Boards Bureau (BBB) to manage board appointments, are significant first steps toward greater professionalism. The BBB's objectives are to allow public banks to operate with less government interference by professionalising the appointments process to bank boards and addressing inefficiencies in hiring, which have contributed to significant delays in the appointment of leadership at state-owned banks.

The extent that government interference is minimised - despite its position as a majority shareholder and major source of capital - will have an important bearing on whether the reforms meet their stated objectives. Two private sector managing director/CEO appointments at large state banks - Bank of Baroda and Canara Bank - which were announced as part of the reform plan, will be an important test case for whether new leadership will be able to reform bank cultures.

The plan also highlights a new framework of accountability which aims to reward capital efficiency and operational productivity in line with previously established objectives to transition banks towards more sustainable commercial practices. The objectives are not entirely new, though it is notable that the plan signals a deliberate move away from the previous performance-measurement system which strongly emphasised asset and deposit growth.

To support the reforms, the plan calls for a INR700bn (USD10.7bn) capital injection by FY19 which includes INR250bn for FY16. This announcement helps to reiterate the government's position to inject new capital, and should provide the necessary room to support public banks' ailing balance sheets.

However, the capital budgeted may not be sufficient, depending on growth expectations and how supervisory capital ratios develop for the banks. The government's expectation that public banks will be able to raise an additional INR1.1trn (USD16.9bn) in required core capital from the markets also seems overly ambitious, considering persistent low equity valuations. Valuations are unlikely to change until asset-quality woes begin to be addressed in a meaningful way.

In addition, the government's intent to follow through on its stated objective to minimise interference in public banks' business decisions remains somewhat uncertain. The ability of new leadership at the public banks to address both internal and external challenges to reform is also a key question, while resistance from unions to new hiring practices remains a risk.