Privatisation not an answer to balancing banks’ balance sheets

The ICICI Bank-Videocon controversy makes it abundantly clear that divestment of Public Sector Banks is no guarantee against the travails ailing the banking sector

That India’s government-owned banks are severely stressed and reeling under bad loans, fraud and mounting non-performing assets (NPAs) is fairly well-documented. But the alleged scam at ICICI Bank, India’s second largest private bank with a total asset base of Rs 7.87 lakh crore (September 2017 figure), that recently came to light came as a shock to many. It was unimaginable that a professionally-managed outfit could disburse a corporate loan of Rs 3,250 crore to the Videocon Group involving an alleged payoff of almost Rs 64 crore as quid pro quo to the bank chairperson’s husband and relatives. The controversy, more than anything else, has served to underline that questionable deals, favouritism, conflict of interest and poor corporate governance are not exclusive to public sector banks. It has also added a twist to the debate on whether privatisation is the one-stop cure for all the ills currently plaguing Indian banking.

Those who have been championing denationalisation, including noted economists, have in recent years been recommending that the government withdraw its stake in Public Sector Banks (PSBs). The call for divestment had become much shriller in February following Punjab National Bank-Nirav Modi scam. The government’s Chief Economic Advisor, Arvind Subramaniam, who in the past has advocated allowing PSBs to “fail” reiterated the demand. Corporate associations like Assocham were quick to second him. And just last fortnight, Nandan Nilekani, non-executive chairman of Infosys, stated that public sector banks must be divested before it's too late and their value totally corroded.

In this backdrop, has emerged the ICICI Bank-Videocon scam, which runs counter to the script that the school of privatisation has been advocating. Its argument has been that once professional managements take over, politicians will no longer dictate decisions and banks will begin to operate as any other business should run: for honest profit. This thesis, of course, works on the premise that the private sector is run by individuals who are above corruption. Seventy-three per cent of NPAs in India are thanks to the corporate sector, according to the Reserve Bank of India. Besides, it is all too easily forgotten that major international banking frauds have been schemed from within the private sector; Scams involving Lehman Brothers, Barings, Societe Generale SA, UBS and Wells Fargo are cases in point.

Public banks may enjoy an advantage over private banks in times of crisis, and, hence, their merits need to be reassessed.
Franklin Allen, Nippon Life Professor of Finance Economics, Wharton School

Following the 2008 meltdown, the World Bank advocated a middle path in its Global Financial Report, 2013. It pointed out that there are “sound economic reasons for the state to play an active role in financial systems” while cautioning that too active a role may not be advisable. The same report presents the argument of Franklin Allen, Nippon Life Professor of Finance Economics, Wharton School, on the role of public banks. To quote: “Public banks may enjoy an advantage over private banks in times of crisis, and, hence, their merits need to be reassessed.” He recommends a “mixed system” which allows co-existence of public and private banks with suitable encouragement given to the latter. In short, he does not suggest doing away with government banks altogether.

A patchy record
But what has been the track record of private banks in this country? Jayati Ghosh, a\Professor of Economics at Delhi’s Jawaharlal Nehru University, notes in a column that in the decade before nationalisation in 1969, there was an average of “more than 35 private bank failures every year.” This led to depositors losing their money and promoters of such banks doing a disappearing act. In fact, it was the weakness of the banking sector and its reluctance to cover rural India that led the government to take over the Imperial Bank of India in 1955 and recast it as the State Bank of India.

It was in 1991 that banking was opened up again to the private sector on the recommendations of the Narasimham Committee on Financial Sector Reforms. Initially, 10 private banks were given licences to operate. Five of these had to soon be merged with other banks. According to figures quoted by Thomas Franco, general secretary of the All India Bank Officers’ Confederation (AIBOC), 24 private banks have either folded up or have had to be amalgamated with other banks since 1991. The list includes Times Bank, Centurion Bank, Bank of Punjab, Nedungadi Bank and Lord Krishna Bank. In 2004, Global Trust Bank collapsed and had to be rescued by the Oriental Bank of Commerce whereas IDBI Bank had to be moved to the public sector. “If private banks are really efficient, why do these banks have to be merged with others? Most of these banks were merged with public sector banks. PSBs have become the ‘Neelkantha Mahadev’ (Lord Shiva) to swallow the poison of failure of many private banks,” Franco was quoted as saying following the PNB-Nirav Modi scam when demands to privatise government banks were stepped up.

All is not well with government banks either. The fact that PSBs have huge NPAs and are crippled by mismanagement and political interference is a given. Going by last year’s RBI data, bad loans with government banks stood at Rs 7.34 lakh crore, while the private sector accounted for Rs 1.03 lakh crore NPAs. Two factors must be taken into account while making comparisons — that PSBs have been in existence for a far longer period of time than private banks, and that they have over 70% share of India's banking business.

The great Indian urban-rural divide
Indira Gandhi’s bank nationalisation which led to the takeover of private banks has been severely criticised for being a motivated, populistic move, which was suicidal in economic terms. But going beyond Left-Right politics, there were valid reasons for the government taking that step in 1969. Before nationalisation, there were only 1,833 rural branches in the country since banks were concentrating on urban customers. By 1991, the number of rural branches went up to 35,206, making banking more inclusive. Capital, hitherto concentrated in select urban pockets, was now more accessible by those in rural areas.

It is unlikely that even today, the private sector, driven by profits, would be keen to provide banking services in much of rural India. As things stand, private banks are more concentrated in urban and semi-urban centres and would require stringent government regulation if they are to spread out more evenly. If this is not done, there will be lop-sided development in the absence of PSBs.

As for NPAs, reviews of stressed assets last year by the RBI revealed that many high-profile banks in the non-government sector were hiding their bad loans by restructuring them. So NPAs are not just about PSBs. And favouritism and fraud can impact the functioning of any banking operation in the present environment where political corruption rules. Perhaps, on this count PSBs are more vulnerable.

But does that justify shutting down PSBs? Mass privatisation has not resulted in positive results in several countries. In 1982 and later in 1997, Mexico had to nationalise banks it had privatised. During the South East Asia crisis of 1997, huge bail-out packages had to be allocated to ailing, private banks. Ditto in Russia and Brazil in 1998 and in the US in 2008-09, where the government had to rescue high-profile private sector banks.

According to one view, reforming PSB banks and making them competitive is the answer. It is not an easy task but an essential one. Pressure to maximise profits resulting in risk-prone loans being disbursed must be eased. Key decisions must be left to the bank management and government influence must be minimal.

The wisdom that can be gleaned from several recent financial crises worldwide is that government-run, financial institutions have a key role to play at such times. If the banking sector is taken over by private players, then the government will find it difficult to play a counter-cyclical role of releasing funds during a downturn to save the economy. Non-government banks would see this as counter-productive to their profits. The role played by banks is not limited to what is reflected in their balance sheets.

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