Opinion: Poonam Gupta and Arvind Panagariya:
Dominance of banking by PSBs has also been a hurdle in the way of improving the regulatory regime, which, in turn, hampers the modernisation and, therefore, healthy growth of the sector. This is because RBI has limited regulatory jurisdiction over PSBs. Indeed, this fact has at times provided RBI an easy cover for its own flaws.
Our July 2022 paper, ‘Privatisation of Public Sector Banks in India: Why, How and How Far?’, presented at the India Policy Forum of the National Council of Applied Economic Research (NCAER), has led to a lively debate on the subject. We appreciate the subsequent advocacy of public sector bank (PSB) privatisation by others such as the former Reserve Bank of India (RBI) governor Duvvuri Subbarao as well as constructive commentary from experts holding a differing view.
But we cannot help noting that the majority among the critics relied on the usual tactic of asking rhetorical questions such as:
Can private banks deliver on social objectives?
Haven’t there been big frauds in the private banks too?
Did India not escape a major fallout from the global financial crisis due to the robustness of PSBs?
Such whataboutery amounts to nothing more than obfuscating the bottom-line issue: when all costs and benefits are considered, is the balance in favour of maintaining the status quo, or privatisation of some or all PSBs? Policies may have some downsides. And, yet, we should adopt them whenever the upside unambiguously outweighs the downside.
In assessing the benefits of PSB privatisation, the first point to recognise is the criticality of a well-functioning banking sector for sustained rapid growth in a developing country. Banks must perform the function of mobilising the savings of savers and allocating them to the most productive investment projects. Failures at either end – mobilisation and allocation – can cost the economy heavily in terms of growth forgone.
Today, with GDP at $3 trillion, even the loss of one-percentage-point growth due to a poorly functioning banking sector would amount to losing $30 billion or more in extra GDP every year. The difference between growing at 7% versus 8% is a GDP of $5.9 trillion versus $6.5 trillion in 10 years’ time. The extra income from 1% additional growth each year can give the government far more resources to pursue social goals than any potential shortfall arising out of its ownership of fewer than the current 12 PSBs.
Evidence points to PSBs as having done a significantly poorer job than private banks when it comes to mobilising as well as allocating the savings to productive investments. On the mobilisation front, they have rapidly lost the share in total deposits to private banks. On the allocation front, they have accounted for disproportionately large share of loans that had to be written off in recent years. These non-performing loans (NPLs) cost the economy dearly in terms of growth, not only because the investments failed to translate into output but also because credit growth by the poorly performing banks came to a near standstill.
On top of that, the taxpayer had to foot the bill for the rescue of the banks. GoI had to spend a massive $57.45 billion to recapitalise the PSBs between 2010-11 and 2020-21. Each of the 12 PSBs required a significant sum out of these recapitalisation funds. Market valuations of some of these PSBs remain below the amount of taxpayer funds infused into them.
In comparison, among private banks, only Yes Bank required a rescue. And even that was accomplished without using taxpayer money. Moreover, its market valuation quickly rose above the value of resources devoted to the rescue. Also notable is the fact that during the NPL crisis of the last decade, credit by private banks continued to grow at a rate significantly higher than that by PSBs.
Holding to Account
Dominance of banking by PSBs has also been a hurdle in the way of improving the regulatory regime, which, in turn, hampers the modernisation and, therefore, healthy growth of the sector. This is because RBI has limited regulatory jurisdiction over PSBs. Indeed, this fact has at times provided RBI an easy cover for its own flaws in regulating the banking sector as a whole.
GoI is not only the owner of PSBs but also their policymaker and regulator. This is contrary to the principles of good governance. The staff of these banks remains subject to oversight by vigilance agencies that seriously undermines their ability to take even normal risk in lending. With salaries of senior staff capped by government rules, PSBs remain handicapped in hiring high-calibre managers and technical staff. At the same time, near-iron-clad job guarantee has resulted in resistance to productivity-enhancing change at all levels.
Any benefits of PSBs must be evaluated against these costs. It must also be asked whether the delivery of those benefits requires as many as 12 PSBs. For example, private banks have been as effective at delivering on priority-sector lending as PSBs over the last four decades. Even if there are goals on which PSBs can potentially deliver more effectively, one must evaluate the benefits of achieving those goals against costs.
We must also ask whether such goals cannot be achieved by retaining just one or two banks in the public sector. Will the nation not be better served if the government owned one or two banks and managed them effectively, instead of shelling out crores of taxpayer money every 5-10 years on keeping several of them afloat, and undermining the modernisation of the banking sector?