Fifty-one years after bank nationalisation, the Centre has finally decided to kick off the privatisation of public sector banks (PSBs). The government owns more than a 70 percent stake in 10 of these banks and over 90 percent in three. Privatising PSBs is expected to bring in much-needed capital and better operational efficiency in these banks.
At least, that’s the expectation.
For years, PSU Banks have acted as vehicles for the rollout of populist government schemes and the social banking agenda. Without a doubt, PSBs have taken banking to rural India where private banks are largely absent. But, their governance standards and operational efficiency have been questioned.
Should India privatise its government-owned banks? The question is as old as bank nationalisation itself. India first nationalised banks in 1969. Reversing bank nationalisation is a politically sensitive step. Despite expert suggestions, no government has shown the political will to implement privatisation. It isn’t hard to see why—unlike mergers, privatisation is a politically sensitive step. But, the government seems to have a plan this time.
“It may take time. But you need to start the process at some point. government ownership continues to be an overhang on these banks in terms of valuation and underperformance,” said Siddharth Purohit, Senior analyst at SMC Global Securities in Mumbai. “These are hard reforms and needed to attract investors,” he added.
PJ Nayak panel
The last major occasion when the subject came up for discussion was in 2014 when the RBI-appointed PJ Nayak panel submitted its report reviewing the governance of bank boards in India. Advocating that the government should bring down its stake in PSBs, the panel, under PJ Nayak, former Axis Bank Chairman and CEO and former Country Head, Morgan Stanley India, explained a raft of benefits associated with such a move.
It said given the lower productivity, steep erosion in asset quality and demonstrated uncompetitiveness of public sector banks, the recapitalisation of these banks would impose significant fiscal costs for the government. If the governance of these banks continues as at present, this will impede fiscal consolidation, affect fiscal stability and eventually impinge on the government's solvency, it said.
“Consequently, the government has two options: either to privatise these banks and allow their future solvency to be subject to market competition, including through mergers; or to design a radically new governance structure for these banks, which would better ensure their ability to compete successfully, in order that repeated claims for capital support from the government, unconnected with market returns, are avoided,” the panel said.
Governance difficulties in public sector banks arise from several externally imposed constraints, the Nayak panel said. These include dual regulation by the Finance Ministry and RBI, board constitution, wherein it is difficult to categorise any director as independent; significant and widening compensation differences with private sector banks, leading to the erosion of specialist skills; external vigilance enforcement though the CVC and CBI.
According to the panel, if the government stake in these banks were to reduce to less than 50 percent, together with certain other executive measures, all these external constraints would disappear.
“This would be a beneficial trade-off for the government because it would continue to be the dominant shareholder and, without its control in banks diminishing, it would create the conditions for its banks to compete more successfully. It is a fundamental irony that presently the government disadvantages the very banks it has invested in,” the Nayak panel said.
But the recommendations, except the creation of a Bank Boards Bureau, which happened in 2016, remained largely on paper.
Return of the P-word
The government finally acted when it asked Life Insurance Corporation of India (LIC) to take over IDBI Bank in 2018 and LIC subsequently completed the acquisition in 2019. But, no one calls this privatisation in its true sense. After all, LIC is owned by the government.
The IDBI deal was followed by a mega-merger exercise. In one go, the government merged 10 PSU Banks into four, effective April 2020. According to this plan, Punjab National Bank (PNB) absorbed Oriental Bank of Commerce and United Bank, creating the second-largest bank after State Bank of India (SBI). Similarly, Syndicate Bank merged with Canara Bank, and Union Bank of India absorbed both Andhra Bank and Corporation Bank. Also, Indian Bank took over Allahabad Bank.
Finally, the government, in Union Budget 2021, announced its plans to privatise two state-run banks. The names of these two candidates are not known yet. But there is speculation that the Bank of Maharashtra, Bank of India, Central Bank of India and Indian Overseas Bank are being considered for privatisation in the first phase.
Moneycontrol recently published an analysis on these four banks.
The government has to face the wrath of trade unions while implementing the privatisation plan. Bank employee trade unions, that have a significant say in industry affairs, do not like the idea. Unions are worried about whether privatisation will lead to job losses. They also question the logic of such a move.
“This is a very serious and politically sensitive matter. We are posing this question to the government — is privatisation the solution for PSU banks’ problems?” said CH Venkatachalam, General Secretary of the All India Bank Employees Association (AIBEA). The unions, Venkatachalam said, are willing to discuss the issue with the government.
Employees have threatened to go on strike to press their demands. On Friday, AIBEA, the largest union of bank employees in India, issued a statement warning that ten lakh employees and officers of different banks would go on strike on March 15 and 16, 2021. This would be followed up by an indefinite strike, it said.
“If the government proceeds further, we will intensify the agitation and go for prolonged strikes and indefinite strikes. We demand of the government to reconsider their decision,” the association said in a statement.
Can privatisation address bad loan woes?
Venkatachalam has a valid point. PSU banks have huge asset-quality worries. Can merely privatising these lenders address the problem? Of the total bad loans in the banking system, over three-fourth are on the books of state-run banks. As of December 2020, PSBs have total Gross NPAs of Rs 5.77 lakh crore and private banks around Rs 1.65 lakh crore. A good part of the NPAs is from large corporate accounts. A loan becomes an NPA if there is no repayment of interest or principal for 90 days. That apart, banks have written off around Rs 8 lakh crore in the last decade.
A Bad Bank could offer temporary relief to PSBs’ bad loan worries. The government’s plan to set up a bad bank (essentially an asset reconstruction company), which will absorb the existing bad loans of banks, assumes greater significance in the context of privatisation.
If the government exhibits strong political will (convincing the influential trade unions) to proceed with the privatisation agenda, it will have to first implement the bad bank plan to clean up balance sheets.
If the books are healthy, there could be potential takers among NBFCs and business houses for these banks, else the plan may not take off in the desired way. Buyers will only be interested in taking over healthier, well-run banks rather than taking up the burden of weak, poorly governed banks.