Shadows of commuters are cast on the road in Amritsar, India (Photographer: Brent Lewin/Bloomberg)

Towards The Stealth Privatisation Of Indian Banking

Anyone who has tracked Indian banking knows that privatisation has been the holy grail of the sector.

In 1998, a committee headed by former Reserve Bank of India (RBI) governor M Narasimham had recommended that the government reduce its stake in public sector banks to 33 percent. The recommendation was part of a wider set of reforms suggested – which included consolidation – to ensure a healthy Indian banking sector that can meet the needs of a newly liberalised economy.

In the Budget speech of 2000-01, then Finance Minister Yashwant Sinha said, “...government has decided to accept the recommendations of the Narasimham Committee on Banking Sector Reforms for reducing the requirement of minimum shareholding by Government in nationalised banks to 33 percent. This will be done without changing the public sector character of banks and while ensuring that fresh issue of shares is widely held by the public...

Sinha explained that this had become necessary because banks needed capital and the government’s finances were strained. In the same speech, Sinha recommended other measures to clean up public sector banks including a Financial Restructuring Authority, that could supersede the boards of weak banks. He had added that recapitalisation of weak banks would be attached to a strict restructuring plan.

As an aside, anyone reading that speech today could be forgiven for thinking that Sinha is addressing the current crisis in Indian banking.

But I digress.

Sinha’s call to privatise the Indian banking sector was not heeded back then. Seventeen years later, though, there is a different kind of privatisation being attempted in the sector.

The government’s share in individual banks is not being reduced but the share of government banks in Indian banking is being pushed down. Call it privatisation of Indian banking by stealth.

The Weak Get Weaker

The shift links back to the government’s Mission Indradhanush program announced in 2015. As part of that plan, the government set aside Rs 70,000 crore for capital infusion into banks over four financial years. The amount was nowhere near what these banks actually needed. Rating agencies, analysts, and bankers all called for a greater allotment of capital to sustain the country’s public sector banks.

The government refused to yield.

The result has been that public sector banks have been forced to curtail growth in their loan books, since the priority was to use the available capital to clean up their books. State Bank of India is an exception but most smaller state-owned lenders have cut back on lending.

Private sector banks have been quick to capitalize on this. Most have grown at rates well above the system average and gained market share.

Data compiled by BloombergQuint shows that private bank advances made up 29 percent of outstanding non-food credit advances as of December 2016. In March 2015, this proportion was at 27 percent. In March 2014, it was still lower at about 24.7 percent.

Only a few banks have reported earnings for the March 2017 quarter so far, but when all numbers are in and tallied, the end of financial year market share for nationalised banks would certainly be lower than the previous year. To be sure, nationalised banks could wrest back market share if they have the capital to clean up and grow but it doesn’t look like the authorities are in a hurry to do that.

Earlier this week, RBI Governor Urjit Patel appeared to give an official stamp of approval to this changing market dynamic.

The stronger banks are gaining market share, which is a good thing, particularly the private sector banks. In a way it is working; those who need to shrink are shrinking. Lenders who are stronger are gaining more market share. I think there is a nice shift happening and we need to work with that to resolve this.
Urjit Patel, Governor, Reserve Bank of India

There are other more subtle shifts taking place in the financial services sector as a whole, which also have the effect of reducing the dominance of public sector banks.

Whether it is the increased borrowing through the bond markets and non banking financial companies (NBFCs), which is taking away a share of the wholesale and retail lending business, or nimble financial technology firms making inroads into the payments business.

Put together, all of this will mean disintermediation away from the banking sector in general and away from public sector banks in particular.

In Defence Of Public Sector Banks

The shift may seem like a classic example of a market economy at work. The fittest survive. But in a country like India, it would be foolhardy to think that state-owned banks don’t still have a role to play. Private banks, as they should, will prioritise profit and return. They may be expanding their presence in rural areas and microfinance right now, but a couple of quarters of volatility could well make them change course.

Besides, each successive government has used public sector banks for objectives that it deems to be in ‘public interest’. If the previous government used public sector banks for infrastructure lending (which now haunts these banks), the current government has used these lenders to push its Jan Dhan program and, more recently, its digitisation drive.

Also Read: Public Sector Bank Boards Should Be Made More Accountable: Bimal Jalan

“You must remember the public banks are doing a very important job,” former RBI governor Bimal Jalan told BloombergQuint in a conversation earlier this month.

For example, if you look at rural areas or semi rural areas, you will find all banks who are operating there are public sector banks. So they are providing access to the persons who didn’t have access to banks. So private sector banks should operate and public sector banks should also operate.
Bimal Jalan, Former Governor, RBI

In final analysis, the economy may be best served by creating fewer, larger, and stronger public sector banks. That too, seems to be underway. After the merger of State Bank of India with its associate banks, speculation is rife that smaller regional lenders will be merged with larger ones.

If – and it’s still a big if – that happens, we may finally see the consolidation and privatisation of Indian banking in one shot.

Ira Dugal is Editor - Banking, Finance and Economy at BloombergQuint.

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