Interview |Bank privatization will reduce long-term loan exposure, says former chief statistician

Asked about bank privatization, Reserve Bank of India (RBI) Governor Shaktikanta Das said in a recent interview that the central bank was ownership-neutral. An article published in the RBI bulletin this month suggested that a big bang approach to privatisation of government-owned banks may do more harm than good. Public sector banks have better than private sector counterparts on counts such as financial inclusion and have a sounder credit system, the article said.

Fomer chief statistician Pronab Sen, in an exclusive interview to Moneycontrol on August 25, spoke about how privatization would affect the banking model in India. Edited excerpts:

Why do you think there is such a massive asset-liability mismatch in the Indian banking system? Will bank privatization worsen it? 

Due to the backing of the government, public sector banks can take risks that private banks cannot afford to take. The long-term loans of the private banks are very small so they keep their asset-liability position in some sort of balance, essentially by focusing on working capital and other short-term loans. For large investment projects, most of them (loans) are carried by public sector banks. Private sectors banks are not going to allow such asset-liability mismatches; they will start reducing long-term loan exposure. Privatization will run the risk of having insufficient funds for such capital investments. The reason this is happening is because we closed the development financial institutions like IDBI (Industrial Development Bank of India), IRBI (Industrial Reconstruction Bank of India) that would give long-term loans.

The entire fixed capital investments are done by PSBs… private banks are not going to take such risks. What would end up happening is that there would be excess funds for short-term loans and a huge shortfall of long-term funds. Banking laws need to change if privatization needs to take place.

PSBs have more cases of willful defaults. Won’t privatization help deal with that? 

Reason for defaults on long-term borrowings is because the commercial banking sector simply doesn’t have the capacity to either properly assess or to monitor fixed investments. There is a structural problem in the banking sector.

In the last quarter, for a couple of PSBs, the net profit has come down considerably while private banks have performed comparatively better. Isn’t that a major reason why the government is focusing on privatization?

That is the reason but that is a bad reason. Yes, government is looking at profitability. But at the end of the day, the concern of the government should not be profitability. The concern should be whether or not the banking sector is providing funds for general economic growth. Now, the PSBs have nearly 50 percent of the portfolio of long-term loans, but the private sector banks have less than 15 percent.

If the banks are giving short-term loans mostly, these are linked to inventories. In long-term loans, banks can take over the assets. But the by the time the bank gets hold of the assets, they are already devalued. So in insolvency and bankruptcy, banks hardly get back 10-20 percent of their loans. Fixed assets like building and equipment don’t have a ready market unlike law materials.

A recent RBI bulletin mentioned that privatization can affect rural banking. Do you think so? 

Rural banking is relatively expensive, as bank branches need to be opened and there will be a certain minimum cost involved….the deposits they get are not that large while the deposit base is far higher in any average urban branch. So rural branches actually don’t make too much profit. So private sector banks don’t like to open rural branches, they need to be forced to open rural branches.

But PSBs don’t have a choice, they have to open (rural branches) as the government forces them to open (the branches). But the moment the banks get privatized, they are likely to close rural branches.

You spoke about a European and Japanese banking model being implemented in India. What aspects of those banking models do you think can be implemented in India? 

European banks and Japanese banks are allowed to raise money in the capital market for all lending purposes. Under Indian banking laws, which is British banking law, banks can’t do that. They can raise money in the capital market only for their own capital.  This should be done immediately in India.

The biggest advantage of that is that banks get to take a call on what should be the proportion …of deposit funds and funds borrowed from the capital markets.

The banks there will issue 20-year bonds in the capital market. So, that has a 20-year tenure there as against deposit tenure, which is a two-year tenure on average in India. If the average tenure goes up, the tenure of your liability goes up. So, on the lending side, if the tenure is of average seven to eight years, banks will be borrowing from capital markets so the tenure of the liability also matches.

You spoke about focusing more on Micro, Small and Medium Enterprises (MSMEs) in loan disbursal instead of focusing on privatization. How will that help a sustainable banking model? 

The banking model in India treats each loan as if it is a standalone loan. So they evaluate each and every borrower in terms of their individual risk probability. But if they take the approach of giving a large number of small-ticket loans, the risk is spread out and the overall default probability actually comes down. But banks can’t use that model with large companies and corporate entities. Such companies have to be evaluated on an individual basis. But for MSMEs, many small-ticket loans can be disbursed...