Should India go for wholesale privatisation of banks?

Apparently, the stage is being set to privatise all public sector banks (PSBs), except the SBI for now, with multiple news reports hitting the headline simultaneously in the recent past. But all these are coming from two channels – unnamed government "sources" and a think tank.

The unnamed government sources have been quoted as saying that a bill may be introduced in the monsoon session to allow the central government "a complete exit" from banks to be privatised by amending the Banking Companies (Acquisition and Transfer of Undertakings) Act of 1970, which requires it to hold at least 51% stakes. The bill is, however, missing from the list made public so far.

At present, only two PSBs, are supposed to be privatised – as per the 2021 budget's "AatmaNirbhar Bharat" package. The NITI Aayog is reported to have identified the Central Bank of India and Indian Overseas Bank for the purpose. It is also reported to have recommended the Indian Bank and Bank of Baroda for privatisation. The Aayog hasn't made the details public. Besides, it is merely following up on the budget announcement without asking questions or disclosing how and why will that benefit the economy or the people.

Why NCAER seeks wholesale bank privatisation

The second source is Delhi-based think tank National Council of Applied Economic Research (NCAER) – a public-private venture. According to multiple news reports, one of which is listed in its website. The think tank is understood to have proposed in a policy paper of July 2022 that all PSBs should, "in principle", be privatised, except the SBI for the time being, and that corporate entities should be allowed to bid for PSBs – that is, run banks.

This policy paper has not been made public yet but news reports say three reasons have been offered for this: (i) private banks have emerged as a credible alternative to PSBs with substantial market share (ii) government ownership hinders the ability of the Reserve Bank of India (RBI) to regulate the sector and (iii) except the SBI, all PSBs lag behind private banks in all major performance indicators during the last decade with soaring NPAs and operational costs. Arvind Panagariya, former NITI Aayog chief, is one of the two authors of this paper.

He had earlier, on February 5, 2021, advocated allowing corporates to run banks claiming that India was facing "acute problem of credit deprivation". The very same day, the RBI's "Monetary Policy Statement, 2020-21 Resolution of the Monetary Policy Committee (MPC) February 3-5, 2021" had said India was credit surplus and facing macro-financial risks due to prolonged cheap credit regime. It had said: "Systemic liquidity remained in large surplus in December 2020 and January 2021, engendering easy financial conditions."

The third source is an internal working group (IWG) of the RBI, which had proposed in November 2020, that large private industrial houses should be allowed to set up and run banks. The only logic that it provided for this was to increase credit-to-GDP ratio from the current level of 50% to more than 150%, in line with many developed economies, to boost growth.

What is worth noticing is that the central government has not spelt out its views in the matter so far. In the past, it has offered two arguments: (a) the government has no business to be in business and that (b) private sector "wealth creators" should be allowed to create wealth so that it could be redistributed among the poor.

While the first logic (a) is deeply flawed, particularly after the 2007-09 global financial crisis, which was sparked by private banking and other financial institutions running amok, the second assertion (b) is contrary to all evidence. The pandemic years of FY21 and FY22 have seen soaring corporate profits accompanied with shrinking jobs and wages. Even before the pandemic hit, private investments were falling, banking frauds and rich businessmen fleeing India after defaulting and diverting bank loans to tax havens were rising and so was the case with writing off of huge corporate loan defaults as NPAs.

Bank privatisation is also counter-intuitive because of India's experience with private banking before nationalisation drive which began in 1969.

Why were banks nationalised?

The RBI's own account of bank nationalisation offers three banking reasons (apart from political ones). These are:

• Lack of banking facilities for agriculture, small-scale industrial units and self-employed.

• Bank expansion during 1951-1967 "un-served" rural and semi-urban areas as focus was firmly on urban areas.

• Private banks were "seen as being excessively concerned with profit alone" and "unwilling to diversify their loan portfolios".

The RBI's account further notes that the sectoral share of credit was far more skewed in 1950-51 and 1966-67 in favour of big industries and the distribution of bank branches was skewed against rural, semi-urban and urban/metro areas. Post-nationalisation, the sectoral shares and distribution of branches witnessed marked changes, making them more evenly matched – indicating that sectors of the economy have been better served and geographical spread widened.

The first casualty of de-nationalisation of banks would then be revival of the pre-nationalisation skewed trends. This would hit small enterprises, particularly in rural areas. MSMEs are a big a source of employment, 51% of which are in rural areas. The state of MSME finance remains unsatisfactory, despite various credit schemes launched after the pandemic hit. The K-shaped recovery of the economy in FY22 is yet another evidence. An analysis of corporate accounts showed while profit continue to be concentrated at the top of corporation ladder, small and public sector firms were struggling to make profits.

The second adverse impact would be on social commitments and financial inclusion, which PSBs are called upon to helm: (i) job reservations for SCs, STs and OBCs (ii) zero-charge, no-frill Jan Dhan Yojana (PM-JDY) accounts for the unbanked through which direct cash transfer schemes like PM-Kisan, Ujjwala, pensions to elderly, disabled and widows and also wages under the MGNREGS are given and (iii) MUDRA loans to self-help groups (SHGs) and small rural entrepreneurs.

Private banks, which have legitimate claims to being profit-driven and outside the "affirmative" government programmes like PM-JDY and MUDRA, can neither be asked nor expected to carry such activities which are beneficial to the people and the economy.

The difference between public sector and private sector in driving growth and development of a populous and poor country like India is best explained in the words of Arun Maira, former Planning Commission member during the previous UPA regime, who had spent all his life in corporate sector until then.

In his 2015 book "An Upstart in Government", he wrote: "…the scope of the government's responsibilities is much larger than that of any private sector company. To produce outcomes that are equitable, and not only efficient, in providing health services to all citizens, for example, is more difficult than selling medicines to only those who can pay the price that covers their cost of discovery and production. The government's job is not to make profit. It is to improve the world for everyone. 'Making profit is easy: changing the world is hard', was the poignant statement of a business management student at an international conference on business responsibility."

The third impact would be massive macro-financial risks emanating from private banking failures.

When the Global Trust Bank (GTB) collapsed and its hapless depositors were abandoned, it was a PSB which bailed it out in 2004. The GTB was merged with the Oriental Bank of Commerce (OBC). In the past few years, several private banks and non-banking NBFCs have collapsed. Some of them were bailed out by government entities like PSBs and the LIC. For example, when the Yes Bank collapsed, the SBI was asked to step in and save it. When the IL&FS collapsed, the LIC and SBI were asked to do so. When the DHFL – linked to the Yes Bank scam – collapsed following a massive corruption scandal, the RBI went for its bankruptcy proceedings; there was no such bail out for it.

With no PSBs, who will bail out private banking failures?

The Insolvency and Bankruptcy Code (IBC) of 2018, brought in to resolve stressed assets, has demonstrably failed with recovery of debts falling to a new low of 16.6% by the end of March 2022. This is far lower than 25% recovery under the earlier Bureau of Industrial and Financial Reconstruction (BIFR) mechanism.

The fourth adverse impact will be rising banking frauds.

Banking frauds have gone up since 2018 – as the RBI reports show. In the meanwhile, a wrong impression has gone around that private banking is safe. Although PSBs have a higher share of such frauds (both in number and value), private sector banks are fast catching up.

Here is a disturbing data from the RBI's annual report of 2021-22. It shows, in FY20 private sector banks' share of frauds were 35.2% in number of cases and 18.5% in value, which jumped to 58.6% in numbers and 29.1% in value in FY22. That is, the number of banking frauds are more in private sector.

A recent analysis of loan defaults shows another disturbing trend. Wilful defaults – defaults by those who have the ability to pay but don't pay – has risen 10-times in the past 10 years from ₹23,000 crore in FY12 to ₹2.4 lakh crore in FY22. These defaults are of ₹25 lakh or more and 95% of money is owed to PSBs.

Not to forget, India's private corporate sector is heavily indebted to banks! World's fourth and India's richest man Gautam Adani's Adani Group's debt mounted to ₹2.2 lakh crore (or $26 billion) in FY22. The group has now sought another loan of ₹14,000 crore from the SBI.

These are significant numbers to ignore.

Lessons from developed economies

When the Great Recession of 2007-09 hit the world economy, it was found that private banks, shadow banks and other private financial institutions had played a major role in it. The US had to bailout many, including the Bank of America, Citigroup, AIG and Bear Stearns, all at a huge cost to its taxpayers. The US also nationalised two big shadow banks (NBFCs) in the housing mortgage markets, Fannie Mae and Freddie Mac, who had, by then, run up a combined debt of $5.4 trillion.

Apart from tightening regulations, developed economies began increasing government-ownership (asset share) in banks. A 2013 World Bank report, "Rethinking the Role of the State in Finance", had shown developed economies raised their public holding and justified this by saying that government-ownership of banks were critical in "stabilising aggregate credit" and played key roles in limiting damages during 2007-08 in several countries, including in India and China. India was saved by its PSBs, and so was China.

As for allowing large industrial houses to run banks, here is a lesson from the US.

The US laws don't allow corporations to run banks, which specifically prohibit big industrial houses with ownership and controlling stakes in non-banking business (manufacturing and others) from owning or controlling banks. Even then, the 2007-09 financial crisis emerged from the US and derailed the global economy.

In-house wisdom

As for addressing poor performance of PSBs (including rising NPAs), both the root causes and solutions are known for a long time. Multiple committees have spelt these out in the past.

In 2020, former RBI governor Raghuram Rajan and his then deputy Viral Acharya had strongly advocated against privatisation of PSBs and explained why. They wrote: "It would be a mistake…to sell a public sector bank to an untested industrial house. Far better to professionalise public sector bank governance and sell stakes to the broader public – that would help promote a shareholder culture, as well as distribute wealth more widely…It would be 'penny wise, pound foolish' to replace the poor governance under the present structure of these banks with a highly conflicted structure of ownership by industrial houses."

They had earlier argued that "corporate houses must be kept from acquiring significant stakes, given their natural conflicts of interest". They advocated regulatory and market reforms to improve banking, including bank governance and ownership, in line with other experts' committees – Narasimham Committee (1991) and Nayak Committee (2014).

Apart from them, several eminent economists warned India against handing over banks to corporates after the RBI's IWG report of 2020 suggested this. Kaushik Basu, former chief economic adviser (CEA) to the Indian government and World Bank economist, wrote it was "almost invariably a step towards crony capitalism". Former chief economic adviser (CEA) Arvind Subramanian, Shankar Acharya and Vijay Kelkar wrote in an article together that "mixing industry and finance will set us on a road full of dangers – for growth, public finances and the future of the country itself".

The Indian government can ignore all these historic and contemporary lessons at its own peril.