Tread carefully on privatisation of banks

AN article in the latest RBI bulletin on the privatisation of public sector banks (PSBs) has ended up playing the role of being a cat among the pigeons. This has made the RBI issue a clarification that the article reflects the views of the authors and not that of the central bank.

The RBI has pointed out that the article was against the big bang approach to privatisation which could do more harm than good. A gradual approach will ensure that large-scale privatisation does not create a void in fulfilling the social objectives of financial inclusion and monetary transmission.

The matter has triggered a controversy, with the Congress claiming that the Centre had pressured the RBI to “disown” its own research. The Opposition party has called upon the government to publish a White Paper which will clarify where exactly the government stands.

Before we go into what the article said, it is important to remember that its findings are based on strong statistical research and that in tone and content, the article is not an opinion piece per se.

To begin with, the current government is indeed in favour of rolling back the footprints of an overextended public sector and has announced its plan to privatise two PSBs in the current year. But it has also clarified that it will not totally exit the strategic sectors where at least one public sector entity will remain. This is expected to be achieved in the banking sector with the State Bank of India remaining under public control.

The article begins by noting the role that the PSBs have played in taking forward financial inclusion. The PSBs have the largest share of branches in rural and semi-urban areas. They also dominate in meeting the credit demand of rural areas.

Their share of ATMs in rural areas is more than twice that of the private sector banks and their share of business correspondents in rural areas has consistently remained above 60 per cent. Banks were nationalised in the first place because they had till then, the 1960s, served only metropolitan areas.

A key developmental initiative of the government is the Pradhan Mantri Jan Dhan Yojana which seeks to offer universal access to banking, with every household having at least one basic bank account. The PSBs are host to 78 per cent of such accounts.

Importantly, private banks have met their priority sector lending targets not by lending directly in sectors like agriculture and to small and marginal farmers but by buying priority sector lending certificates.

These are issued by the PSBs against their own priority sector lending portfolios in excess of the mandated levels which are, thereby, in a sense, refinanced. Private banks don’t mind paying a premium on these certificates instead of actually going out and engaging in priority sector lending.

A key argument used in favour of privatisation is that the staff in private banks are more efficient than their PSB counterparts. The statistical analysis used by the article indicates that the labour cost efficiency of PSB staff is higher than that of private bank staff.

The article says that by “incurring lower cost on labour, PSBs can generate higher levels of output.” This may have been achieved through the effective use of the banking correspondents model and other cost-efficient techniques.

The statistical exercise sought to measure output against input. Output consisted of deposits, advances, non-interest income and investments. Input consisted of staff cost, rent, lighting, insurance, taxes and other administrative expenses. The measure deployed was output achieved per unit of input.

Anecdotal evidence indicates that private bank staff treat customers across the counter better. On the other hand, the private banks pick and choose their customers who have a relatively higher net worth and, therefore, are fewer in number and easier to give service to.

The PSBs have consistently allocated a larger share of their lending to agriculture and industry. They have earnestly taken up the challenge of successfully conducting agricultural lending. As for the industry, only very large or reputed concerns and those which have high credit ratings can access the capital markets. So, most of the industry, leaving aside these, have to rely on banks for finance to run their businesses and also to make investment in fixed assets like plants and machinery.

This has been particularly true since the downturn in the Indian economy began in 2017-18. By continuing to lend to the industry during this period, the PSBs have played a counter-cyclical role that is sought to help the industry fight the downturn.

The PSBs have also played a key role in financing infrastructure, a government priority, whose expansion alone can enable growth. Other than the budgetary allocation for large public sector concerns, a big part of the infrastructure financing needs of the economy have been met by the PSBs. This role has become more critical as developmental financial institutions like the IDBI, IFCI and ICICI of yore have withered away.

The PSBs have also played a key role in the monetary policy transmission — the speed with which the monetary policy signals coming from the RBI are responded to, thus helping the policy meet its goals. When the RBI loosened its purse strings by, among other things, lowering the interest rates it offered during the economic downturn caused by the Covid pandemic, the PSBs were more prompt than the private banks in lowering their own interest rates.

On the other hand, their deposit rates were particularly stickier. This has caused the private banks to be ahead of the PSBs in earning a higher net interest margin (difference between the interest earned and paid, the main source of bank income). Expectedly, the private banks are more profitable than the PSBs.

The big question that arises out of all this is that if the PSBs play a bigger role than the private banks in enabling the success of not just the government but also the RBI policies, then should virtually the entire banking sector be nationalised, as it was after two rounds of bank nationalisation?

The short answer to this is that the PSBs need to run efficiently and the only measures known in any modern economic system to judge the efficiency of business organisations are their profit margins and the efficiency parameters that they are able to achieve. For this, the PSBs, for the most part, need to run like any privately-owned business institution. Ideally, the government and monetary policy goals that they help deliver should be hived off into separate business units whose cash flow deficits can be measured and reimbursed.

Additionally, the PSBs need to have managers who are professional and whose achievements can be measured. The present government set up the banks’ board bureau to make the top management of the PSBs more professional and create a buffer between them and the government. But it did not work. The reality is that India’s ruling politicians and senior bureaucracy remain unwilling or unable to stop interfering with the running of the PSBs.