Is banking a mere profit making business?

It would be wise on the part of the Union government to ensure an efficient, productive,  inclusive, and trustworthy banking system where the public and private banks could coexist for a healthy profit writes Dr. NVR Jyoti Kumar, Head. Department of Commerce, Mizoram Central University.

Hyderabad (Telangana): Through the announcement in the Union Budget regarding the privatization of two Public Sector Banks (PSBs) in the current fiscal year, the Finance Minister made it clear the Union government’s intention to change the banking landscape in India. This could be considered the beginning of the process of reversing the major policy decision of the Government of India to nationalize the major banks 51 years ago. After the massive consolidation exercise merging ten PSBs into four undertaken by the Government recently, the number of PSBs in the country now has been reduced to merely 12 from 27.

Banking, Insurance and financial services is one of four strategic sectors specified by the Government where it would like to retain a ‘bare minimum presence’ of public enterprises. Therefore, this exercise of privatization of two PSBs should be considered the tip of the iceberg of the Narendra Modi government’s mega privatization plan, and as part of it, the Government has set an ambitious stake sale target of Rs.1.75 lakh crore for FY 2021-22.

The NITI Aayog recommended excluding six banks from privatization that were a part of the recent phase of consolidation (perhaps in the first round). They are Punjab National Bank, Union Bank, Canara Bank, Indian Bank, Bank of Baroda and State Bank of India. There are news reports that the Government may not take up for immediate privatization of Indian Overseas Bank, Central Bank of India and UCO Bank which are under the prompt corrective action framework of the Reserve Bank of India (RBI). This leaves Punjab & Sind Bank, Bank of Maharashtra and Bank of India to be privatized immediately. Overall, the undue delay on the part of the Government in clarifying which two PSBs they want to privatize is only making the employees of PSBs feel further threatened due to uncertainty over their future.

Why Privatization?

The steep rise in the Non-Performing Assets (NPAs) of PSBs continues to pose a serious challenge over a period of time. Against the backdrop of the COVID pandemic, the economy has been suffering as a result of which the gross NPA ratio is projected to increase from 7.5% in September 2020 to 13.5% in September 2021, as reported in the RBI’s recent Financial Stability Report.

This will further necessitate the Government to infuse more capital flow to the PSBs. In the last couple of years, the Union government has invested large amounts through recapitalization bonds and capital injections – Rs.70,000 crore (FY 2019), Rs.80,000 crore (FY 2018) and Rs.1.06 lakh crore in FY 2019 as recapitalization bonds. An amount of 3.19 trillion rupees of taxpayers’ hard earned money have been poured into PSBs to keep them going during 2014- 19.

Though the government is trying to justify the privatization of select PSBs on the ground of some other reasons such as ensuring profitability, improving productivity, and enhancing customer services, the crux of the issue lies with its reluctance to extend support by injecting capital year after year. Such a critical situation faced by the Union government as ‘employer’ could be construed as its inability and inefficiency, to turn around the PSBs and lack of political will to revamp the system by utilizing the regulatory framework to deal with the influential wilful defaulters in the corporate sector.

PSBs’ Commendable Role

The Government is facing severe criticism from the experts of the banking sector for labelling the performance of Indian PSBs as low based on a short-sighted criterion of profitability alone, by conveniently disregarding the developmental goals such as ensuring banking services accessible even to the most disadvantaged groups of people across the country for which the major banks were nationalized.

“After nationalization, the breadth and scope of the Indian banking sector expanded at a rate perhaps unmatched by any other country,” Abhijit Banerjee, a Nobel Laureate in economics is one among many economists who applauded India. Such a massive expansion of PSBs empowered the governments to leverage the benefits of accomplishing the desired legitimate socio-economic obligations of inclusive development such as access to credit by marginalized sections of the society viz. farming community, small business people, and people involved in the non-farm sector in rural areas thereby generating employment and poverty reduction.

PSBs, Victims of Political Decisions

There exists unanimity among the economists who opine that privatization of the banking sector is not healthy for a developing economy like India. For example, stating that the growth of the economy was inextricably linked to the credit linkage by banks, Y.V. Reddy, an internationally reputed banking expert and economist said that India could take a cue out of Japan and Germany where governments draw capital from banks and use it for taking up infrastructural projects.

The PSBs in India became victims of the Government’s policy decision as they were compelled to extend huge loans for infrastructure projects of big corporates due to the conversion of IDBI, ICICI and IDFC into all-purpose banks. Many studies reveal that the extent of NPAs and NPAs ratios were significantly higher in PSBs than in private banks. This could also be attributable to PSBs’ liberal and loose credit policies and having highly concentrated loans on certain borrowers in specific sectors, namely infrastructure, power, mining and telecom. The RBI has failed in playing the role of a regulator in managing PSBs effectively and efficiently compared to private and foreign banks, and also in safeguarding the PSBs from constant political interference especially since the 1980s.

Privatization, not a Panacea of all Ills

In fact, the pace of privatization has increased in the past five years while PSBs have struggled with a huge burden of bad loans. The market share of PSBs as a proportion of overall lending in March 2010 was over 75%. Since then, PSBs’ share has been gradually coming down, and as of September 2020, it was 57%. During this period of ten years, the private banks’ share in lending doubled from 17% to 35%. However, the PSBs’ share in total deposits did not decline much. From 74% of market share in March 2012, the PSBs’ market share declined to 62% in September 2020. This indicates the private banks’ ability to compete well, though the PSBs are perceived as more trustworthy by the people when it comes to deposits.

Despite the key role played by the PSBs since the nationalization in expanding the banking sector in terms of the number of branches, technology and business correspondents, still, the banking sector continues to be metro city-centric. For example, at the end of 2018, 53 metro centres that account for one-fifth of total branches had over 50% of deposits; they lent 64% of total advances. The urban places with almost the same number of branches (19%) had only a share of 21.5% deposits and a mere 15% of the total advances. The branches in metros were giving almost Rs. 97 as loan out of Rs. 100 deposits received (called credit deposit or CD ratio); it is just 55% in urban areas. In general, the reluctance of banks to open brick and mortar structures in rural and hilly areas resulted in poor access to banks.

This underlines the need to bank on PSBs in achieving inclusive development through priority sector lending to farmers and small entrepreneurs in the economy which the private banks consider financially unviable. The Narendra Modi government depended heavily on PSBs in popularizing various financial inclusion schemes such as Pradhan Mantri Jan-Dhan Yojana (PMJDY), PM Garib Kalyan Yojana (PMGKY), PM Jeevan Jyoti Bima Yojana (PMJJBY), PM Suraksha Bima Yojana (PMSBY), Atal Pension Yojana (APY), and PM Mudra Yojana (PMMY) to reach out the vulnerable sections of the society. It would be irrational to argue that the PSBs should aim for only profitability as a pure business enterprise by ignoring its legitimate role of achieving social responsibility.

Further, we should recall that India could withstand the 2008 Global Financial Crisis mainly due to its robust banking system characterized by the dominance of PSBs. Mere merging of banks would not ensure better governance automatically. The often-cited inefficiencies are not confined to PSBs only. The studies on the international experience of the banking sector do not support the view that the banks in the private sector have more capability in managing NPAs. Similarly, there is no evidence to support a view that private banks have been able to avert frauds totally.

The Way Forward

About 19 crore adults in India are still without a bank account which suggests the immediate need to bring such a huge population into the fold of the formal banking system. India also lags behind on different inclusion indicators and considering banking as a mere business enterprise would amount to allowing it to not fulfil its legitimate responsibility as a social engineer and change agent to achieve the goal of sustainable inclusive development. Thus instead of limiting to a ‘bare minimum presence’ of PSBs in the strategic sector, it would be wise on the part of the Union government to ensure an efficient, productive, inclusive, and trustworthy banking system where the public and private banks could coexist for a healthy profit. At the same time, we need to ensure banks primarily focusing on social banking with adequate fiscal support. With regard to corporate governance, the Union government should allow the RBI to exercise its functional autonomy by ensuring the level playing field between PSBs and private banks by being a neutral umpire.