What’s wrong and right with PSU banks

The third week of July marks two anniversaries of events in 1969, one national and the other international. The latter was the first human landing on the moon which happened around 8 am on a Sunday morning in India. Just twelve hours before that, the Prime Minister announced to the nation, that the government was taking over 14 private banks, and nationalising 85 percent of the nation’s deposits. One event was a technological breakthrough while the other demonstrated political audacity. Each event had a long-term influence, one on the evolution of the space exploration program, and the other on the evolution of banking and finance. We will leave the story of Apollo 11, whose crew came back safely to earth, and the subsequent developments, to a later day.

The public perceived, rightly or wrongly, that their money was safe in public sector banks. That feeling persists to this day.

For now, let’s focus on the long shadow of bank nationalisation. The economy has grown 50 times larger since 1969. The bank deposits with those 14 public sector banks were not even 100 crores then, while today Public Sector Banks (PSBs) hold over a 100 lakh crores in deposits. The deepening of the financial sector, its formalisation and its spread into every corner of the country has been phenomenal.

After fifty-three years, the share of deposits with PSB’s are still at 70 percent, which is a fall of merely 15 percent since that day of nationalisation. Incidentally the Prime Minister had rushed through nationalisation, even getting Presidential assent on a Saturday. But this hasty legislation was defeated by the Supreme Court just six months later, and hence a modified ordinance had to be passed to overcome the court hurdle. The Prime Minister gained immense popularity and political mileage from this decision since there had been hundreds of private bank failures in the previous twenty years. The public perceived, rightly or wrongly, that their money was safe in public sector banks. That feeling persists to this day. Even this government has shown disproportionate dependence on PSB’s rather than private banks.

The quantum of bad loans or what are called non-performing assets (NPAs) is much worse for PSBs in comparison with private banks

For instance, more than 90 percent of the Prime Minister’s Jan Dhan Yojana of 45 crore accounts were opened by PSB’s. This is the world’s foremost financial inclusion campaign and has helped channel government subsidies through direct benefit transfers to the JDY accounts. Even during COVID these accounts have proved invaluable. They also have an insurance cover as well as an overdraft facility attached to the accounts. The Mudra loans to small enterprises are also mostly an exclusive domain of PSB’s. On the credit side too, the bulk of the loans for government’s projects, whether in ports, roads or railways or other infrastructure endeavours are through PSB’s. A recent example is the Bundelkhand Expressway in Uttar Pradesh, whose estimated cost is 15,000 crores. Loans for the Expressway have been raised from a consortium of PSB’s. 

As for bank failures, there too the PSBs come to the rescue. Yes Bank recently was de facto taken over by State Bank of India (although not technically). The ill-famed Global Trust Bank was bailed out by the Oriental Bank of Commerce back in 2004.

If one looks at only the commercial performance of PSBs the picture is mixed to put it mildly. The quantum of bad loans or what are called non-performing assets (NPAs) is much worse for PSBs in comparison with private banks. A recent report by the credit information company TransUnion Cibil shows that willful defaulters, i.e., against whom the banks have initiated legal action, have increased by 10-fold in the past ten years. As of March 2021, these defaulters owed 2.4 lakh crores, of which 95 percent of the amount was owed to PSB’s. This amounts to a loot of public funds. Of these there are 36 people who have defaulted on more than 1000 crores each. The chances of recovery are remote, and in any case the legal process is longwinded.

The question is whether this implies negligence of the lenders, lack of vigilance on the loans, or lending under some political pressure? The negligence argument is not convincing, since for example, 30 percent of those loans were given by State Bank of India or its associates, who are all known for high standards of diligence and lending practices. Why is it that private sector banks have low non-performing asset ratios? Are they better at loan monitoring? Are they better custodians of public deposits? Do they inherently take less risks? Is it because they don’t lend to socially desirable but commercially non-lucrative borrowers? Or is it because they don’t face political pressure to lend?

The view that privatising banks is the panacea for all ills of banking in India is obviously wrong. All bank failures have been of high-profile private banks. The mother-of-all bank failures occurred in 2008 in America and among the western nations, starting with the fall of the gold-plated Lehman Bank and the domino effect resulted in a global financial crisis. Surely public sector ownership of banks was not to be blamed for this crisis.

Around the same time in late 2008, a cash-rich company like Infosys had to publicly announce that it was moving its cash deposits from private and foreign banks to State Bank of India, and that its shareholders or customers should not panic! The instinctive flight of public deposits to PSB’s indicates the trust and confidence of depositors.

There is however a flip side to this confidence. It is because of an implicit guarantee by the owner of the PSBs i.e., the government of India that no bank will fail. This un-priced guarantee can result in poor profitability. Is it fair that the public depositor should have an unlimited guarantee that her or his money in the PSB is safe? Should there not be an upper limit (say 5 lakh rupees) above which funds are at risk of bank failure? The answers to these and many such questions lie in banking reforms, which include more autonomy in their running, more commercial orientation, a lower burden of pursuing social objectives, more focus on manpower productivity and a better pricing of depositors’ risk.

The wrong answer is outright and wholesale privatisation of all PSB’s as was proposed recently in a paper authored by a former NITI Aayog Chairman and a present member of the Prime Minister’s Economic Advisory Council. Surely a middle path can be found, wherein government ownership is reduced, functioning autonomy of the PSB is increased, the public’s trust is maintained, deposit insurance is properly priced and the commercial performance of banks is enhanced. This is not rocket science, unlike that moon-landing in 1969.

(Dr.Ajit Ranade is a noted economist)