Bank privatisation: The key parameters the RBI did not talk about

There is always a buzz around bank privatisation. Every budget is surrounded by anticipation on why PSU is likely to be privatised, particularly state-run banks. Policymakers have often dwelt on the subject.

Recently, a policy paper authored by Poonam Gupta, NCAER Director General and member of the Economic Advisory Council to the Prime Minister (PMEAC), and Arvind Panagariya, former NITI-Aayog Vice Chairman and Columbia University professor, recommended the privatisation of all public sector banks (PSBs) except State Bank of India. Earlier, NITI-Aayog had recommended the privatisation of three PSB — Bank of Maharashtra, Indian Overseas Bank and Punjab and Sind Bank. In 2021, Finance Minister Nirmala Sitharaman, in her budget speech, indicated that two banks would be privatised.

Meanwhile, bank employee unions have been protesting vociferously against the privatisation plans, even resorting to strikes.

Also read: 7 reasons why RBI is against big-bang privatisation of PSU banks

What the RBI study said

It is in this context that the Reserve Bank of India (RBI), on its website, published a study titled Privatisation of Public Sector Banks: An Alternative Perspective. The article compared PSBs with private sector banks (PVBs) and found the former shining in several key parameters.

For instance, it found that PSBs are not entirely guided by profit maximisation, and have integrated financial inclusion goals in their agenda. Further, their lending plays a key countercyclical role in the financial ecosystem, and these banks stood like a rock amid the COVID pandemic.

It’s an empirical study conducted in an unbiased way, but it’s beyond comprehension why it does not reject privatisation outright. It only suggests gradual privatisation, as opposed to a ‘big-bang’ one. What the study fails to point out is that PVBs have underperformed in several key matrices, and hardly present an attractive goal for privatisation. They are by no means the gold standard as far as financial institutions go, and PSBs are probably better off in their existing avatar.

There are five key assessment points that the study has omitted from mentioning. These points should, in fact, be applied to banks when their financial and operational health is being studied. We take a look at them.

Multiple bank failures

The study has not touched upon the failure of several private banks in the country, and how people lost money before the nationalisation of banks in 1969. The banks were bailed out after 1969 using money from PSBs.

Also read: Cong slams Centre over privatisation of banks, cites RBI report to corner govt

There were 900 bank failures from 1935 to 1947 alone. From 1947 to 1969, 665 banks failed. The customers of these banks lost their deposited money.

After the nationalisation of banks in 1969, 36 banks failed but these were rescued by getting them merged with government banks. A bank as big as Global Trust Bank met a similar fate before it was amalgamated with Oriental Bank of Commerce. Recently, the RBI came to the rescue of Lakshmi Vilas Bank and Yes Bank by arranging capital infusion in them. 

Several cooperative banks have also faced closure. There were 1,926 town cooperative banks in 2004; the number shrank to 1,551 in 2018.

Need for repeated capital infusion

Over the years, the government pumped capital into banks to ensure capital adequacy norms were met and banks continued with their lending operations. Though this is definitely desirable, it is out-of- budget allocation, and the government has to bear the cost.

However, the government has found an accounting gimmick by which it provides capital to the banks but takes it back by way of investment in government bonds (recapitalization bonds). The table below shows the flow of out-of-budget funds over the years.

Year	Capital infusion (in ₹ cr)
2007-08	1,900
2008-09	1,200
2009-10	20,117
2010-11	12,000
2011-12	12,517
2012-13	14,000
2013-14	6,990
2014-15	25,000
2015-16	22,915
2016-17	10,000

Over the 10-year period ended 2016-17, the government infused ₹1.3 lakh-crore in the banks. While presenting the budget in 2020, the government did not announce any capital infusion in PSBs. The FM said that over the years, the government had infused ₹3.5 lakh-crore into PSBs, and asked them to move to the capital market for fund-raising purposes.

While presenting the budget in 2021, FM had announced a ₹20,000 crore capital infusion for PSBs. For 2022-23, no specific amount was allocated. In Budget 2022-23, the government trimmed the capital infusion target to ₹15,000 crore from ₹20,000 crore estimated for 2021-22.

When the government makes continuous infusion of capital, there should be a commensurate return also. The market value of government holdings in government banks is around ₹4,80,000 crore. When we see the present dividend yield of some of the PSBs, we can understand the return is not significant. For instance, SBI’s is 1.36 per cent, BoB 2.37 per cent, PNB 1.92 per cent, Canara Bank 2.82 per cent and Indian Bank 3.66 per cent.

Any discussion of bank privatisation has to necessarily touch upon capital infusion, which this study has not.

Excess leverage by private banks

Private banks are in the habit of making loans and advances not only out of deposits mobilised but also from the borrowed funds. Their credit-deposit ratio is always on the higher side.

When the borrowed funds dry up, it leads to a dangerous mismatch of assets and liabilities, which may result in the bank’s failure. Then the burden will be shifted to the RBI, as lender of last resort. In all the private bank failures, we can see this phenomenon of excess leverage.

Also, PSB staff are governed by the vigilance machinery of the government and institutions like the Central Vigilance Commission (CVC) and Central Bureau of Investigation (CBI). This makes sure they adhere to the norms.

Also read: Freebies have costs, parties must make it clear to voters: RBI’s Ashima Goyal

This type of supervisory machinery is not available for private banks, and their employees are often encouraged to take risks for profit maximisation. As the saying goes, higher the potential gain, higher be the risk.

Non-performing assets

The study has not dealt with the NPAs of public sector and private sector banks.  The NPAs of public sector banks are always on the higher side and it is a fact that not even one PSB exists in the top 5 list of lenders with the lowest NPAs.

A banks’ efficiency study cannot be complete without adequately covering the NPA aspect.

Pruning government holding

The study has not covered the percentage of government holding in PSBs. With just a 51 per cent stake, the government can ensure that PSBs retain their public sector character while having effective control at less cost.

The government’s holding in PSBs, as of March 2021, is rather high:

Bank	Total govt & RBI  holding (%)
Bank of Baroda	64.0
Bank of India	89.1
Bank of Maharashtra	93.3
Canara Bank	69.3
Central Bank of India	89.8
Indian Bank	88.1
Indian Overseas Bank	95.8
Punjab and Sind Bank	97.1
Punjab National Bank	76.9
State Bank of India	56.9
UCO Bank	94.4
Union Bank of India	89.1

It is not clear why the panel has not recommended dilution of capital in all these banks just to maintain the level at 51 per cent. Instead, it has recommended gradual privatisation.

Where the study scores

All along, policy makers were suggesting privatisation based only on the efficiency measured in terms of profit to shareholders. But this study has underlined the importance of other parameters, as it provides empirical evidence on how PSBs have been more welfare-enhancing than their private sector counterparts in India.

The results also suggest that when profit maximisation is the sole motive, the efficiency of PVBs has always surpassed that of their public sector counterparts. However, when the objective function is changed to include financial inclusion like total number of branches, agricultural advances and PSL (priority sector lending) advances, PSBs prove to be more efficient than PVBs. That way, this study should be an eye opener for policy makers.

However, just when the media began to amplify the study, the RBI has rushed in to clarify that the views expressed in the article are those of the authors and not those of the central bank itself. It’s possible that the suggestions of the latest study did not find favour with the ruling dispensation.

(The writer is a retired banker.)