The fiscal risk posed by the current pension liability management of public sector financial institutions (including the RBI) need to be recognised and addressed.
The December 2013 Financial Stability Report (henceforth FSR) by the Reserve Bank of India (RBI) has expressed serious concerns about soundness and resilience of India’s financial institutions. Thus, the 2013 FSR estimates that the sum of Gross Non-performing assets of Scheduled Commercial Banks (SCBs), and their restructured advances, called the stressed advances ratio, rose significantly from 9.2 percent of total advances in March 2013 to 10.2 percent in September 2013. The largest contribution to stress advances was by the public sector banks.
The 2013 FSR projects that if there is contagion, (failure of a major corporation triggering banking system wide losses due to interconnected nature of bank credit), and if 30 percent of restructured assets are written off, the loss of capital of banking sector could be around one-third of the total. This would require government to inject INR 2 Lakh crore in equity in banks.
The projected infusion of equity into banks represents significant fiscal risk at the time when combined union and state government deficit was 7.3 percent of GDP in 2012-13; total liabilities of the union government alone was 66.7 percent of GDP in 2012-13; and India’s annual economic growth rate around 5 percent, much lower than around 9 percent assumed when banks extended credit over the last several years. India’s gross domestic saving to GDP ratio has fallen significantly from 36.8 percent in 2007-08 to 30.1 percent in 2012-13, with the steepest fall ( from 5 percent to 1.2 percent) exhibited by the public sector.
The inflation rate has also remained stubbornly high (annual rate of around 8 percent), largely due to lack of structural reforms designed to address supply side constraints. This has reduced the potential for achieving higher rate of non-inflationary growth.
It is in the above context that the fiscal risk posed by the current pension liability management of public sector financial institutions (including the RBI) need to be recognised and addressed. While the focus in this analysis is on the banks, similar case exists for the insurance sector where public sector has a dominant markets share; for government provident funds such as the EPFO (Employees provident fund Organisation); and health sector such as Employees State Insurance Corporation (ESIC). If any of these organisations are unable to meet the pension liabilities, the contingent liability and fiscal risk will be on the state.
Pension Benefits Arrangements: The employees of the public sector financial institutions joining before 1st April 2010, with the exception of those employed by the State Bank of India (SBI), are covered under a Defined Benefit (DB) arrangement incorporated in the Bank Employees’ Pension Regulations of 1995. The pension benefits of SBI employees are governed by the SBI Pension Fund Rules of 1955. Under the DB arrangement, pension plan sponsor bears the risk of pension liability. The promised benefit design, including the pension formula, which normally includes the extent to which pension benefits are linked to inflation rate or wage rate, is a key aspect of overall pension arrangements.
As pension liabilities are for long term, and as life expectancy has been increasing, (for India, the current estimates are that an average Indian men on reaching age 60, can be expected to live on the average for another 17 years, the corresponding figure for women is 19 years) matching of long term pension assets and liabilities at each organizational level is essential. The usual practice is to require actuarial reports at regular intervals (preferably every three years), and make these reports accessible to the stakeholders, including the pension plan members.
The significance of accurately projecting future liabilities is illustrated by the special provision for pension liabilities made by the State Bank of India (SBI) in its third quarter report for Financial Year 2013-14. The Report makes provision of INR 1800 crores for the nine months of 2013-14, equivalent to one-tenth of total staff expenses, contributing to the decline in net profit of 27 percent for the period as compared to the correspond period in 2012-13.
Currently, all public sector financial institutions, regardless of their financial health or viability, essentially have similar pension arrangements. This puts severe strain on financially weak banks, increasing the probability that ultimate economic burden of meeting their pension liabilities will be on the government, i.e. the taxpayers of India.
The National Pension Scheme (NPS): Those employees joining public sector financial institutions after 1st April 2010 are covered under the NPS. The NPS is a defined contribution scheme through which employees contribute 10 per cent of their monthly income and the employers contribute 10 percent towards the pension fund. The withdrawal at retirement is through a combination of lump sum payments and mandatory annuities. The NPS, unlike the previous arrangement is portable and its benefits begin from the first month of joining the organization. The investment return and other risks are with the employee rather than the employer. But as NPS is a government mandated arrangement, the ultimate fiscal risk is still on the government, whether at the Union or at the state government level.
Even with the introduction of the NPS, the pension liabilities under the pre-2010 DB arrangement will still need to be managed over the next four to five decades. However, unlike in the case of pre-2010 arrangements where no funds are set aside to meet current and future pension liabilities, the NPS provides for creation of financial assets from pension contributions. The NPS is also portable, and compels financial discipline on employers to contribute to pensions every month. The NPS therefore on balance is arguably a more secure method of pension provision than the current arrangements.
The Size of Pension Liabilities: There are no estimates of the size of the future pension liabilities of the public financial institutions as a group for India. The estimates are that the current employment in public sector financial institutions exceeds one million persons. Future growth in the employment in these institutions, salary revisions, mortality and morbidity patterns, and other features will impact on the future pension liabilities.
The data on the ratio of current pension recipients to current staff of public financial institutions, either as a group, or more relevantly on an individual institution basis, are not available. This gap needs to be filled for more informed discussion of the financial viability of these institutions, and for assessing future fiscal risk.
It is hoped that as part of the broader banking reform, bringing greater professionalism, competence, and transparency to the management of pension liabilities of public sector financial institutions will be given due consideration. The RBI can lead by example by revamping its own pension arrangements to reflect these attributes.
One, Undertake actuarial analysis spanning next 20 to 30 years (developing different scenarios) of the dynamics of pension liabilities of individual public sector financial institution, and for the group as a whole. Periodic actuarial reports need to be mandated and made public.
Two, Each institution must be asked to set aside a special fund for meeting future pension liabilities over a period, with share of liabilities met from such a fund increasing over time. There needs to be requirement of the trustees of pension funds having appropriate skill-sets on a collective basis.
Three, In employment practices, full cost, including pension, gratuity, and other benefits, should be explicitly taken into account.
Four, Encourage variation in pension arrangements among different public sector financial institutions, while improving their capacities to meet pension liabilities.
Five, Bring the pension arrangements of those under the NPS in all public sector institutions under the regulation of the PFRDA (Pension Fund Regulatory and Development Authority).
Six, Encourage pension financial literacy among all stakeholders, including the understanding that pension arrangements should be sustainable over a long term (around 50 plus years); and that there is a “tyranny of small numbers” leading to seemingly small variations in rate of return or in life expectancy leading to disproportionately large impact on financial viability.
Photo: Gerard Van der Leun