Analysis | Budget 2021 lays foundation for change in banking sector landscape over next decade

The Union Budget proposal to divest two public sector banks (PSBs) next year, if successful, is likely to accelerate the change in the banking sector landscape in the country over the next decade. During the last decade, given the weak capital position of the PSBs, their market share in loans declined from 82 percent as of March 2010 to 62 percent as of September 2020 notwithstanding the sizeable capital infusion of over Rs 4.01 trillion by the Government of India (GoI) during this period. The public banks continue to remain a large mobiliser of domestic savings with a relatively higher share of deposits at 70 percent of the banking sector as of September 2020 (83percent as of March 2010). Given the high level of stressed assets of these banks in relation to their net worth, the move towards privatisation will reduce further capital infusion into these banks.

Apart from political consensus and legislative changes, the GoI will have an uphill task of bringing all the stakeholders such as employees, investors and depositors on board and convince them of longer-term benefits of the move. The key factors to success for privatisation will however be the ability of the new management to retain and grow the deposit base while instituting asset side strategies led by process changes and upgradation of employee skills. After the amalgamation among PSBs, six PSBs were left out of consolidation process, of which three banks, i.e. Indian Overseas Bank, UCO Bank and Central Bank of India are under prompt corrective action framework of the Reserve bank of India (RBI).  While the GoI has not named the banks that could be privatised in this round, GOI may looked at PSBs that have turned around or where asset quality concerns are largely addressed. If successful, it is highly likely that more PSBs, including the larger ones could be offered for privatisation in future, given the intent of the GoI to have limited number of entities in strategic sectors. As a result, we can expect a steady gain in the market share of private banks over the next decade, which will be in line with the intention of GoI to reduce its presence in the banking sector.

While privatisation of public banks is a welcome move, we must remember that the private sector banks have not been immune to failures. Though there is no precedence whereby the depositors of scheduled commercial banks have taken a hit, private banks will have to continuously strive to improve their deposit franchise and public confidence given that deposits form a large part of a bank’s balance sheet and also account for the majority of domestic household savings. Despite a hike in deposit insurance in March 2020, the insured deposits account for just around 50 percent of the total system deposits. A further increase in deposit insurance amount in future may enable private banks to scale up faster with increase in depositor confidence on private banks.

The budgetary proposal to create an asset reconstruction company (ARC) and transfer bad loans of lenders to this company is fundamentally positive as it can speed up the debt consolidation and enable a faster resolution while freeing up the bank’s bandwidth to focus on core lending operations. While we await granular details on the structure and operation guidelines of the ARC, it is important to understand that mere replacement of non-performing assets with investment in ARC, will not result in an improvement in solvency profile of the lender.

The budgetary proposal to create an asset reconstruction company and transfer bad loans of lenders to this company is fundamentally positive as it can speed up the debt consolidation.

While the above steps are targeted for implementation in the next year, in the interim, the GoI has allocated the requisite capital of Rs 200 billion for PSBs for next year. This is in-line with our estimates, assuming that the PSBs shall be able to roll over the Additional Tier I (AT-I) bonds falling due for call option next year. A trend of improved AT-I issuances is already visible this year with more public banks raising capital through this route.