Public versus private banks: The case made for both in an RBI paper

Far from arguing against privatisation, the RBI paper attracting Opposition ire presents the pros and cons of both ownership structures

A paper by Snehal S Herwadkar, Sonali Goel and Rishuka Bansal of the Reserve Bank of India (RBI) on “Privatisation of Public Sector Banks: An Alternate Perspective” is being seen for what it never claimed to be. The authors’ stance has been erroneously interpreted by the Opposition (and parts of the media) as being reflective of the banking regulator’s opposition to the privatisation of these banks. This approximates “mitempfindung”, basically a condition in which stimulus applied to one region of the body registers in another part. In this case, what was meant to stimulate a conversation around the subject has been reduced to a political controversy.
 

The essence of the authors’ conclusions is that state-run banks are better at financial inclusion whereas their private peers are better at profit maximisation. That the former comes better off in cost efficiency, and helps counter-cyclical monetary policy action to gain traction. It is, of course, possible to argue these issues on either side of the debate — that’s exactly what the paper meant to provoke.
 

What the authors (who work in the Banking Research Division housed in the Department of Economic and Policy Research of the RBI) did not mean was to reduce the privatisation debate to a binary — on whether it is good or bad. Rather, they have pointed out: “From the conventional perspective that privatisation is a panacea for all ills, economic thinking has come a long way to acknowledge that a more nuanced approach is required while pursuing it.”
 

That said, some of the aspects highlighted in the paper are debatable.
 

The authors point to the fact that state-run banks have gained greater market confidence. That despite the criticism of weak balance sheets, data suggests they weathered shocks from the Covid-19 pandemic remarkably well. And that the mega-merger of four sets of these banks has created stronger, more competitive banks. And finally, setting up the National Asset Reconstruction Company (NARCL) will help clean up the bad loans.
 

But much of the above can be ascribed to the significant hand-holding by the government and Mint Road; rather than any brilliance on the part of state-run banks’ management.

Consider recapitalisation to clean up their books, an exercise that was first rolled out in the mid-90s at substantial cost to the fisc. In late 2020, the Comptroller and Auditor General of India (CAG) wrote to the banking regulator and sought details of a study, if any, on the performance of state-run banks after their recapitalisation over the preceding five years.
 

The CAG’s communique came within a year of the Report on Trend and Progress of Banking in India (T&P: 2018-19) noting that “going forward, the financial health of state-run banks should increasingly be assessed by their ability to access capital markets rather than looking at the government as a recapitaliser of the first and last resort”.
 

It also pointed to the deferment of the implementation of the last tranche of the capital conservation buffer (CCB) till end-March 2020, which offered these banks breathing space. The CCB, introduced after the global capital crisis of 2008, is the amount banks have to set aside to absorb losses during times of stress to withstand shocks. To this day, the deferment continues — because it will consume capital. Private banks can’t hope to lean on such privileges, and have to be fit enough to retain investor confidence to raise capital.
 

Next, take corporate governance norms for private banks, which came into being two years ago and reduced the elbow room for corner-room occupants and have put the spotlight on the functioning of their boards. To date, state-run banks have not been put through the wringer on this front. Back in April 2018, then governor Urjit Patel went public that the banking regulator’s powers over state-run banks were hostage to certain clauses in the Banking Regulation Act (1949). Clause 51, for example, restricted bank managements’ say in the removal of chairman or directors in these banks. Forced mergers were another case in point.
 

The short point: Certain kinds of decision-making in the name of nation-building at state-run banks — such as giving loans to fanciful infrastructure projects — may have attracted regulatory censure of a harsher kind had the RBI been the recipient of the same kind of powers it has over private banks.
 

The question, then, is: Does the colour of capital matter in the final analysis? The authors appear to imply it does not when they draw attention to RBI’s supervisory data — on deposit withdrawals in early 2020 in the wake of depositor concerns over the health of Yes Bank and Lakshmi Vilas Bank. Deposit outflows during the episode were not restricted to small private banks alone, but to some state-run banks with weaker financial health, too. The outflows occurred despite these banks offering relatively higher interest rates than others; and typically to stronger banks, both in the state-run and private sector.
 

That said, there’s no reason state-run banks should not continue to be around if governance standards were to improve. It helps systemically to have counterweights to private banks — to enable counter-cyclical monetary policy action to gain traction is a good enough reason.
 

Finally, the frenzied arguments that the RBI was against privatisation of state-run banks is misplaced. The paper had actually complimented the government’s approach: “A big bang approach of privatisation of these banks may do more harm than good. The government has already announced its intention to privatise two banks. Such a gradual approach would ensure that large-scale privatisation does not create a void in fulfilling important social objectives of financial inclusion and monetary transmission.”
 

At some point it would be useful if RBI researchers were to put in public domain a paper on the costs due to supervisory failures, and its systemic impact on the banking sector as well.

Hard copy

• The authors of the paper did not argue against privatisation of state-run banks
• The authors observed that state-run banks are better at financial inclusion; have better cost efficiency, and helps counter-cyclical monetary policy action to gain traction
• It was intended to ignite a conversation in policy making
• The paper salutes the government’s current gradual approach to large-scale privatisation