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Bad to Worse?

One issue that dogged the PSBs more than the PVBs was the unresolved issue of NPAs and cleaning up of their balance sheets.


Privatisation of the public sector is a priority area of the government, but little progress has been achieved in this, save for the sale of Air India to the Tatas. Meagre proceeds from disinvestment for several years now have been a major reason for fiscal deficit targets going haywire. Though the government’s intention of privatising two Public Sector Banks (PSBs) announced in the FY22 budget did not materialise, the prevalent thinking is to ultimately privatise all PSBs including the monolith State Bank of India. A paper ~ “Privatisation of Public Sector Banks: An Alternate Perspective” ~ published in the RBI Bulletin in August 2022, however, advocated a gradual approach instead of a big bang approach for all-out privatisation of PSBs, in line with recent research which suggests that “private ownership alone does not automatically generate economic gains in developing economies” and that “a more cautious and nuanced evaluation of privatization is required”.

Noting that profit maximisation is not the only objective of PSBs which carry social obligations also and that without their support, financial inclusion which was a priority area of government would not have been possible, the paper argued that such a gradual approach would ensure that a void is not created in financial inclusion and monetary transmission. The article offers a counterpoint to the case made out by Poonam Gupta and Arvind Panagariya that the “PSBs have underserved the economy and their stakeholders”. It noted that when profit maximisation is the sole motive, private sector banks (PVBs) may be more efficient, but “when the objective function is changed to include financial inclusion ~ like total branches, agricultural advances and PSL (priority sector lending) advances ~ PSBs prove to be more efficient than PVBs”.

For financial inclusion, the Pradhan Mantri Jan Dhan Yojana was launched which envisages universal access to banking facilities with at least one basic banking account for every household. As many as 78 per cent of the 45 crore Jan Dhan Accounts opened till July 2022 were in PSBs, with more than 60 per cent of accounts opened in rural and semi-urban areas where the PVBs have limited and reluctant presence. PSBs have always allocated a much larger share of their total credit to PSL compared to the PVBs; they also raised higher resources than the PVBs in recent years indicating the growing market confidence in them. During the Covid-19 shock, they played a crucial role in monetary policy transmission by reducing lending rates more than the PVBs at the cost of profitability and served the social purpose by supporting countercyclical macroeconomic policies needed in those difficult times. They also have higher labour cost efficiency than the PVBs, and generate higher levels of output with lower labour cost.

The banking scenario in India has been undergoing substantial transformation in recent times. For several years now, the government has been merging smaller banks with larger ones to achieve higher economies of scale and better synergy to increase their domestic and global competitiveness. In 2017 SBI was merged with its five associates and another bank, followed by the merger of Vijaya Bank and Dena Bank with Bank of Baroda in 2018. This was followed by a megamerger of ten PSBs into four large banks in 2019 when the government also infused Rs 55,250 crore to help the newly merged and some other PSBs to advance more credit and to meet the crucial BASEL III regulatory norms. As the Economic Survey, 2019-20, observed, Indian banks suffer from “dwarfism”, with only the SBI raking among the top 100 banks in the world, whereas the fifth largest economy in the world would need at least six.

The USA has 18 banks among the top 100, China 12, and Japan, South Korea and the UK six each. India’s banking sector is still disproportionately under-developed compared to the size of its economy, which was a major reason behind the merger, because no economy can realise its full potential unless it is supported by its banking sector. Our experience with forced merger so far has been less than encouraging; in fact, the non-productive assets (NPA) often became worse after merger, with write-offs and persistent slippages eating into both profit and capital. Assets of the merged entities increased, but return on assets decreased due to their underutilization in the post-merger period, and consequently the return on equity decreased significantly. It is also unrealistic to expect that a strong bank would clean up the weak bank’s problems, and the results of the latest mega-mergers are yet to show up in improved performance and competitiveness of PSBs, though it has led to the consolidation of the sector.

One issue that dogged the PSBs more than the PVBs was the unresolved issue of NPAs and cleaning up of their balance sheets. The NPAs have indeed been at the root of their trouble. Their steady loss of profitability and yielding of ground to the PVBs resulted from NPAs, for which the Government, the unholy nexus between politicians and industrialists and a culture of crony capitalism were far more responsible than the PSBs themselves. Once politicians got unfettered control over the PSBs, cronyism, corruption and interference became the order of the day, when we especially needed a renewed focus on management, strengthening of regulatory institutions and ensuring public scrutiny. After liberalisation, the PSBs were made to compete with the private sector including foreign banks and chase quick profits which could only come from corporate loans.

But the bank management still remained captive to the politician-bureaucratic nexus which forced the banks to give loans to industries and individuals regardless of their viability. The result was the NPA crisis and ballooning of defaulting loans. The deterioration in their asset quality had its root in the credit boom of 2006-2011 when bank-lending grew at an average rate of over 20 per cent, combined with lax credit appraisal and post-sanction monitoring standards, project delays and cost overruns and absence of a strong bankruptcy regime until 2016. The humongous defaults in loan repayments by an array of illustrious businessmen and industrialists could not have taken place without the active participation, collusion and connivance of the people who controlled the levers of the system. The entire economy has been paying the price of such misdemeanour ever since and the subsequent economic slowdown well before the pandemic can be attributed in a substantial measure to the inability of the PSBs to clean up their balance sheets of the NPAs.

Investment has dried up for their lack of capital and the inevitable casualty was the economic growth which had slumped below 5 per cent before the pandemic. Provisioning for NPAs and writing them off had landed the PSBs in the red, and the Government had to use public funds for their recapitalisation which was inadequate. When PSBs had to restrict their lending due to the Prompt Corrective Action limitations imposed by the RBI, NonBanking Financial Companies (NBFCs) became the major lenders. Their credit flow boosted both investment and private consumption for some time until but the collapse of IL&FS in September 2018 which sent shockwaves through the entire financial system ~ converting the twin balance sheet (Banks and Infrastructure Companies) first into a triple balance sheet problem with the NBFCs, and then into a quadruple balance sheet problem by including their major borrowers ~ the real estate sector.

The resulting public anger has led to increased demands for the privatisation of the PSBs which have also been facing stiff competition from the new generation PVBs which have established an edge in the market in Fintech and are leveraging technology in a way that the PSBs cannot match and consequently lost much of their market share to them. But PSBs have an inherent advantage in having a much wider rural network than any PVB and must leverage this for the “last mile” connectivity to include the rural sector into a modern banking network driven by technology, using the Jan-DhanAadhaar-Mobile trinity to their advantage. Privatising them would deprive the government of control over a very important lever of growth. Fortunately, the culture of leniency that had led to the NPA crisis is now a thing of the past and NPAs have been reduced substantially from their peak in 2018 when the Gross NPAs had amounted to nearly 15 per cent of Gross Lending, to about 10 per cent in 2020, aided by the Insolvency and Bankruptcy Code (IBC) of 2016.

Hopefully, the establishment of National Asset Reconstruction Company Limited (NARCL) will clean up the legacy burden of NPAs, and the recently constituted National Bank for Financing infrastructure and Development (NABFiD) will provide an alternate channel of infrastructure funding, thus reducing the asset liability mismatch of PSBs. Privatisation cannot be the answer to all problems in the public sector. As I have argued in this column and elsewhere, the answer lies in giving them genuine autonomy by eliminating the scope of interference by politicians and bureaucrats and in instituting a robust regulatory system for all banks with multiple checks to cover the identified risks, which is still missing. In the absence of regulation, bad will only become worse and the entire economy will pay the price.

A version of this story appears in the print edition of the September 6, 2022, issue.

The writer is an academic, commentator and author. Opinions expressed are personal.