Banking is considered to be the “Backbone of a Nation’s Economy”. It is the most leading part of the financial sector of the country as it is responsible for more than 70% of the funds that flow through the financial sector in the country.
Indian banking was more or less turned into a tool of state policy by bank nationalization in 1969. While our 1991 reforms did decentralize the allocation of capital overall, lending India’s economy some efficiency, the Centre retained much of its command of credit flows.
PSU banks are under dual control, with the RBI supervising the banking operations and the Finance Ministry handling ownership issues. Many committees had proposed bringing down the government stake in public banks below 51% — the Narasimham Committee proposed 33% and the P J Nayak Committee suggested below 50%.
Timeline of Structural and Technological Developments in the Banking Sector in India:
1955: SBI Act passed and Imperial Bank of India became State Bank of India
1959: State Bank of India (subsidiary banks) Act passed to create subsidiaries of SBI
1969: The government nationalized 14 major commercial banks
1975: Regional Rural Bank was conceptualized to serve the rural population
1987: HSBC first introduced ATM kiosk in Mumbai
1996: Local Area Banks were set up in the Union Budget to mobilize rural savings.
1991: Licenses given to 11 Private Sector Banks
1994: ICICI bank introduced net banking for retail customers in India
2000: Introduction of ATMs in India through countrywide BANCS network
2006: Cash Deposit Machines first introduced in India by ICICI bank, starting from western India
2008: Mobile banking through Mobile Apps introduced, pioneered by ICICI bank
2010: Cheque Truncation System (CTS) introduced, it eliminated a lot of paper and reduced cheque clearing time to a minimum
2014: Automatic Passbook Printing machines introduced in India
2015: Payments banks were given license to operate in India
2016: Prime Minister announced demonetization of Rs. 1,000/- and Rs. 500/- currency notes, led to a forced yet phenomenal increase in the use of non-cash i.e. electronic payments.
2017: EMV chip cards made mandatory in ATM-cum-Debit cards to enhance security.
Banking System in India
Importance of Private Sector Banks
The private sector banks play a vital role in the Indian economy. They indirectly motivate the public sector banks by offering healthy competition.
- Professional Management: The private sector banks help in introducing a high degree of professional management and marketing concept into banking. It helps the public sector banks as well to develop similar skills and technology.
- Creates Healthy Competition: The private sector banks provide a healthy competition on general efficiency levels in the banking system.
- Attracts Foreign Direct Investment: The private sector banks especially the foreign banks have much influence on the foreign investment in the country.
- Access to Foreign Capital Markets: The foreign banks in the private sector help the Indian companies and the government agencies to meet their financial requirements from international capital markets.
- Innovation in the Banking Sector: The private sector banks are always trying to innovate new product avenues (new schemes, services, etc.) and make the industries achieve expertise in their respective fields by offering quality service and guidance. This helps the public at large and they have a range of options to choose between.
- Introduction of new technology: With innovations comes new technologies in the banking sector and they lead the other banks in various new fields. For example, introduction of computerized operations, credit card business, ATM service, etc
What is the government plan on the Privatization of PSBs?
- During Union Budget 2020-21 presentations, the government announced a new policy for strategic disinvestment of public sector enterprises. This policy provides a clear roadmap for disinvestment in all non-strategic and strategic sectors.
- The Banking Sector falls under the strategic sector. The government aims to keep a bare minimum presence in the strategic sector.
- In 2019, after a massive consolidation exercise, the no. of PSBs reduced from 28 to 12. Recently the NITI Aayog consolidation plan left 6 PSBs out of the Privatization plan.
- The NITI Aayog suggested privatizing all the PSBs except the SBI, Union Bank, Punjab National Bank, Canara Bank, Indian Bank, and Bank of Baroda.
- Further, the government also decided to perform privatization of two PSBs in the next fiscal year.
Nationalization and Equitable growth
- Nationalization helped in promoting more equitable regional growth, and this is evident from RBI data.
- There were only 1,833 bank branches in rural areas in the country in 1969, which increased to 33,004 by 1995 and continued to grow over the next decades.
- Banking services also reduced the dependence on moneylenders in rural regions.
- Nationalized banking improved the working conditions of employees in the banking sector, as the state ensured higher wages, security of services, and other fringe benefits.
- As an institution, PSBs are vehicles of the Indian economy’s growth and development, and they have become the trustees of people’s savings and confidence.
- The PSBs played a huge role in making the country self-sufficient by supporting the green, blue, and dairy revolutions.
- They have also contributed significantly to infrastructural development.
- The PSBs pioneered the concept of ‘priority sector lending. This provided credit to certain priority sectors which were earlier deprived of credit such as housing, etc.
- The Differential Rate of Interest (DRI) loans are the brainchild of public sector banking. Under this poorest section of people will receive the loan at a very marginal interest rate.
- The PSBs extended loans to women’s self-help groups under various programs. This contributed to women’s empowerment in India.
- PSBs also funded rural infrastructure projects through the Rural Infrastructure Development Fund.
- The PSBs provided access to a formal banking network for all and facilitated financial inclusion in India.
- Democratization of Banking: Before nationalization, banks had been lending 67% of their funds to industry and virtually nothing to agriculture.
- Also, the commercial banks couldn’t lend money to farmers because they were only present in less than 1% of villages.
- Farmers were unable to get bank loans just when the Green Revolution was getting underway and they needed credit to buy the expensive inputs required to increase output.
- Thus, nationalizing banks helped in the democratization of banking services of the masses.
Reasons for Privatizing Public Sector Banks
- Increasing NPAs: RBI data shows that that 9.3 per cent of the industry loan book for private sector banks was stressed by March 2017, as opposed to 28.8 per cent for PSBs.
- As of end-March 2016, RBI data showed that public sector lenders accounted for over 90 per cent of the Rs. 5.5 lakh crore gross NPAs with banks.
- Poor Lending: PSBs have been criticized for poor lending decisions, inadequate risk controls, and bad governance.
- Previous reform measures have not yielded results: Years of capital injections and governance reforms have not been able to improve the financial position of in public sector banks significantly.
- Many of them have higher levels of stressed assets than private banks, and also lag the latter on profitability, market capitalization and dividend payment record.
- Aligned with Long Term Goal: Privatization public sector banks will set the ball rolling for a long-term project that envisages only a handful of state-owned banks, with the rest either consolidated with strong banks or privatized.
- Reduces Government Burden: Privatization will free up the government, the majority owner, from continuing to provide equity support to the banks year after year.
- The government front-loaded Rs 70,000 crore into government-run banks in September 2019, Rs 80,000 crore in in FY18, and Rs 1.06 lakh crore in FY19 through recapitalization bonds.
- It will be another step towards reducing the fiscal deficit and financing revenue expenditure through revenue receipts in the long term.
- Rationalization of Banks in Post-COVID Scenario: After the Covid-related regulatory relaxations are lifted, banks are expected to report higher NPAs and loan losses.
- This would mean the government would again need to inject equity into weak public sector banks. The government is trying to strengthen the strong banks and also minimize their numbers through privatization.
- Changed Approach to Financial Sector Problems: Privatization and proposal of setting up an asset reconstruction company entirely owned by banks, underline an approach of finding market-led solutions to challenges in the financial sector.
- Private Participation promotes innovation in market: Private Banks’ market share in loans has risen to 36% in 2020 from 21.26% in 2015, while public sector banks’ share has fallen to 59.8% from 74.28%. They have expanded the market share through new innovative products, latest technology, and better services.
- Efficiency, financial prudence and governance: There is a belief that the public sector equates to inefficiency and corruption, while private ownership automatically brings with it efficiency, financial prudence and governance.
- Also, privatizing a few loss-making PSBs will ensure that market discipline forces them to rectify their strategy, and this will have a ripple effect on other PSBs.
- Better financial performance is ensured when a strong financial institution is involved as a significant shareholder in privatization.
What factors aggravated NPAs in PSBs?
- During high growth period, FY07 to FY12, corporate groups has invested in mega projects in power, metals and infrastructure. They were funded by domestic banks.
- By FY13, with regulatory hurdles hitting some projects and scams stalling others, many projects failed to take off and these groups landed in a classic debt trap.
- Many companies took on more loans to manage their debts, which eventually turned into NPAs.
- Which in turn took on a five-fold expansion in their aggregate debt from Rs. 1 lakh crore to Rs. 5.5 lakh crore (present value of NPAs).
- Many PSBs chairman were given high political pressures to sanction loans to the companies which were favorable to politicians.
Factors against Privatization of PSBs
- Undermining Social Welfare: Public banks open branches, ATMs, banking facilities, etc even in the non-profitable rural areas of India or the poorer sides where the possibility of getting big deposits or making money is less.
- However, Private Banks are not inclined to do so and they may prefer opening such facilities mostly in megacities or urban areas.
- If the corporate sector is allowed to dominate banking again, profit will become the prime motive rather than the desire to serve the public.
- The government will have difficulty in providing low-cost financial services to rural and poor sections of society as the private may not like to extend its services to them.
- International Precedent: Most East Asian success stories have been underpinned by financial systems effectively controlled by governments.
- On the other hand, the governments of western countries, where banking is largely in the hands of the private sector, have had to rescue private banks from bankruptcy.
- The past history of private sector banks tells the failure. Before 1969, all banks, except the SBI, were in the private sector. Between 1947 and 1969, 559 banks failed.
- This would totally defeat the idea of inclusive banking as it is practiced now and was the guiding principle at the time of the nationalization of banks.
- Public sector banks are created out of public money. These entities are therefore duty-bound to extend all types of services to customers across categories. Privatization will impact this very root purpose.
- We need a broad set of actions, some immediate and others over the medium-term and aimed at preventing the recurrence of such crises. Wholesale privatization of PSBs is thus not the answer to a complex problem.
- Overall risk management at PSBs needs to be taken to a higher level. This certainly requires the strengthening of PSB boards. We need to induct more high-quality professionals on PSB boards and compensate them better.
- In the case of banking, what is needed is increased autonomy for state-backed banks and strict regulatory oversight by the banking supervisor.
- The boards of state-backed banks should be independent of political influence.
- Managers should be held accountable for operational performance and there should be constant monitoring of targets, risk assessment, and credit controls.
- The clean-up of bank balance sheets and the overhaul of India’s archaic insolvency law are steps in the right direction, but they will only bear fruit if accompanied by improved governance and regulation.
- The Privatization of PSBs is not going to be easy, as it would involve building consensus amongst various stakeholders, including unions and parliamentarians. Further, Bank privatization, without strengthening regulatory controls and improving governance, won’t prevent fraud or curtail undue exposure to risk.
Privatization of banks is not a remedy to all solutions. With steps like Privatization of Banks, the Government should also focus on comprehensive governance reforms, resolution of NPAs, and creating a free market so that investment can be reinvigorated and wheels of the economy can again get back on track. Even though private sector banks have better balance sheets than PSBs, it is very important to consider that Privatization alone would not solve all of the problems faced by the sector. A better solution than privatization may well be giving PSBs autonomy to reform themselves and function free of political interference.