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RBI Bulletin of Aug 2022, which is available on the website www.rbi.org.in titled, “Privatisation of Public Sector Banks; An alternate Perspective” authored by Snehal S Herwadkar, Sonali Goel and Rishuka Bansal of the Banking Research Division of RBI has evoked a lot of response in the mainstream media. TOI reported, “RBI supports Govt’s gradual privatisation of PSU Banks.” “Big bang Privatisation of banks can be harmful, RBI Article” – wrote The Hindu. “Big Bank Privatisation of Banks can do more harm than good,” said the Business Standard. “RBI paper wants gradual privatisation of Banks,” wrote the Financial Express.

It is surprising that none of these national newspapers noticed the footnote in the publication which said that this was not the opinion of the RBI.  This has always been the practice which the financial papers at least should have known. But it is a welcome step that the papers and television channels are taking this issue seriously.

What is more surprising is that RBI became so jittery afterwards, probably because of the Dept of Financial Services and the Finance Minister bent on privatisation and issued a clarification on 19th Aug 2022.

RBI clarification states

i) As clearly stated in the article itself, the views expressed in the article are those of the authors and do not represent the views of the Reserve Bank of India.

ii) The Press Release relating to the August 2022 Bulletin highlights that “the gradual approach to privatisation adopted by the government can ensure that a void is not created in fulfilling the social objective of financial inclusion”.

iii) The concluding paragraph of the article, inter-alia, mentions that:

-“From the conventional perspective that privatisation is a panacea for all ills, the economic thinking has come a long way to acknowledge that a more nuanced approach is required while pursuing it”;

– “Recent mega-merger of PSBs has resulted in consolidation of the sector, creating stronger and more robust and competitive banks”;

– “A big bang approach of privatisation of these banks may do more harm than good. The government has already announced its intention to privatize 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.”

Thus, the researchers are of the view that instead of a big bang approach, a gradual approach as announced by the Government would result in better outcomes.

(Yogesh Dayal)     
Chief General Manager

Press Release: 2022-2023/732

The RBI has not openly stated what is its official position but seems to concur with the views of the author. That means privatising two PSBs first. Now let us analyse the article.

It was a rebuttal to the paper of Poonam Gupta and Aravind Panagariya which has been quoted twice in the article. Read the more critical details of their paper, here.

The article is brilliant but lacks the courage to call a spade a spade in its conclusion.  Probably that is because the authors are not independent as they are employees.  I know of gag orders on researchers put by RBI earlier.

In my view, the highlights of the article are-

  1. In many countries, the share of assets held by the government in the banking sector increased by more than 10 percentage points between 2008 and 2010
  2. Studies have shown that public sector banks have played a key role in catalysing financial investments in low-carbon industries thereby promoting green transition in countries such as Brazil, China, Germany, Japan, and the European Union.
  3. An important aspect that is often ignored by researchers proposing privatization is the role played by PSBs in financial inclusion.
  4. Using Data Envelopment Analysis (DEA) the article presents a performance assessment of PSBs (Public Sector Banks) and PVBs (Private Banks) for alternative objective functions which clearly shows that PSBs are performing better in most of the parameters. Assessing the performance of PSBs and PVBs the article clearly states profit maximisation is the sole motive, the efficiency of the PVBs has always surpassed that of their public sector counterparts. However, when the objective function is changed to include financial inclusion—like total branches, agricultural advances and PSL advances— PSBs prove to be more efficient than PVBs.
  5. It is often argued that the staff in PSBs is inefficient (Gupta and Panagariya, 2022). The cost minimization DEA framework is employed to empirically evaluate this claim. In particular, the average labour cost efficiency of PSBs is compared with that of PVBs. PSBs have consistently allocated a larger proportion of their total credit to agriculture and industry than PVBs. Agriculture lending is a priority, as well as a challenging area. Over time, the share of co-operative banks and RRBs in agriculture lending has reduced while that of PSBs has increased, suggesting that the latter have played an important role in providing credit to the needy sector. Since the corporate bond markets in India are not deep and vibrant, industries had fewer other avenues to raise resources than banks. Earlier research has also shown that larger and stronger industries can access the equity market easily but that option is scarcely available to smaller entities. This was especially true during the cyclical downturn that started in the Indian economy in 2017-18. By providing credit to the industrial sector, the PSBs have played a countercyclical role. Infrastructure finance has been a bottleneck in the country’s development and growth. PSBs have a lion’s share in these lendings and their role has been especially crucial against the backdrop of the withering away of erstwhile development financial institutions.
  6. PSBs are also more effective in monetary policy transmission, aiding the countercyclical monetary policy actions to gain traction. During the last easing cycle, for example, their reduction in lending rates was substantially higher than that of PVBs. At the same time, their deposit rates were relatively stickier as compared with PVBs. The resultant higher NIMs of PVBs are an indication of their profit maximization objective. On the other hand, by playing a crucial role in monetary transmission, the PSBs have contributed to larger social goals.
  7. At the onset of the global financial crisis, deposits flew out of PVBs to PSBs. A viewpoint suggested that this reallocation was not indicative of the better financial health of the bank to which the deposits flew, but rather indicated implicit government guarantees in them. Researchers have argued that this had an adverse and destabilising impact on private sector banks from which the deposits were withdrawn, despite their better health. An analysis of supervisory data available with the Reserve Bank for the episode of deposit withdrawals in early 2020—in the wake of depositor concerns over the health of Yes Bank and Lakshmi Vilas Bank— however, suggests otherwise. Deposit outflows during the episode were not restricted to small private banks alone but some PSBs with weaker financial health also faced the same. The outflows happened despite these banks offering relatively higher interest rates than others. Deposits typically flew to stronger banks, both in the public and private sectors. This shows that investors and depositors value the health of banks much more as compared to implicit government guarantees while placing their trust. It can also be argued that during such stress periods if stronger PSBs had not existed, the destabilising impact on the banking sector and the economy would have been much greater. Such episodes could have easily led to a run on banks resulting in financial dis-intermediation. In that sense, the public sector banks have played a major role in boosting public confidence.
  8. Resources raised by Banks through Private placements

(Amount in crore)

2019-20 2020-21 2021-22
No. of issues Amount raised No. of issues Amount raised No. of issues Amount raised
PSBs 20 29573 36 58697 29 50719
PVBs 8 23121 4 33878 12 35682

In resource mobilisation, PSBs are doing better.

9. The article provides an alternative view with evidence that public sector banks are not entirely guided by the profit maximization goal alone and have integrated the desirable financial inclusion goals into their objective function, unlike PVBs. Their results also point out the countercyclical role of PSB lending. In recent years, these banks have also gained greater market confidence. Despite the criticism of weak balance sheets, data suggests that they weathered the Covid-19 pandemic shock remarkably well.

The final words are contradictory to everything discussed above.  It says, “the government has already announced its intention to privatize two banks. Such a gradual approach would ensure that large-scale privatization does not create a void in fulfilling important social objectives of financial inclusion and monetary transmission.”

Is it necessary to privatise at all?

The statement that mergers have helped to create stronger banks is not supported by any data. AIBEA publication shows it has not improved the performance. Some of the merged entities are struggling due to various reasons. In today’s economic conditions even the privatisation of just 2 banks will create a big crisis. The faith in the public banks will go. This will have cyclical efforts.

Some of the issues in the articles require better understanding.  For example, the definitions of rural, semi-urban, and urban as per RBI are totally different. Village Panchayats are treated as rural for Govt schemes of the Union Govt whereas the RBI definition says “rural centre – population up to 9999, semi-urban – up to 99999, urban – up to 999999 and metropolitan – above 1000000.”

The private bank’s rural branches are at locations with more population than the PSBs. Under the Lead Bank Scheme, Public Sector Banks have opened branches in the interiors of the country where there is a block headquarter, but the population may even be less than 1000.

In the case of financial inclusion, the number of beneficiaries of Public Sector Banks is 36.2 Cr, RRBs – 8.45 Cr and Private Banks – 1.3 Cr.  RRBs are owned and run by Public Banks.  So together they have opened 44.65 Cr accounts, amounting to 97.17% of the total of 45.95 Cr accounts. Where are the private banks whose share in the banking system’s deposits and advances are nearing 40% with the support of the Govt?

Another aspect that the authors have not looked into deeply is the Business Correspondents. Should you encourage exploitation of labour?  For regular employment, BCs are paid only incentives and no regular salary.  They also work under National Business Correspondents who exploit them by taking away 30% of their income. They require to be regularized.

One important factor left out in the analysis is per employee customers of public sector versus private sector banks.  For example as on 2020, per employee customers of BOM was 2500, BOI- 2400, Indian Bank- 2381 and SBI – 1680  whereas it was 467 for HDFC Bank, 353 for ICICI Bank and 325 for Axis Bank. As of March 2022, SBI had 1915 customers per employee and HDFC – 501.  Should this factor not be taken to assess efficiency?

Finally, the empirical evidence in the article clearly shows that there is no need for the privatisation of Indian banks, which are contributing to the growth of vital sectors. Without them, there would have been more poverty and unemployment. Without them, access to banking would have been impossible. Now access to credit is important, which they can bring about if there are more branches, more staff and more small credit. Profit alone cannot be the motto of PSBs. Social banking is the need of the hour to reduce income inequality, already at its peak. India has to be a welfare state and welfare needs public banks! Yes, there is a need to improve their functioning and give priority to the bottom 90%. They should not imitate private banks which are there for profit alone. Let us not forget that banks are run with people’s money, their deposits which are household deposits, not corporate deposits. If the people lose their faith which already started with demonetisation, the economy will collapse.

Let me recall a story. Once a farmer came to a bank for a loan. The branch manager asked for security. He gave his land as security. He repaid the loan with the harvest and closed the loan, and took back his security. The branch manager asked him how he could close the loan so quickly. He replied that he had a good harvest and a good surplus. The branch manager asked him to deposit the surplus in the bank. He asked back, “What security can you give for my money?”

Thomas Franco is the former General Secretary of All India Bank Officers’ Confederation and a Steering Committee Member at the Global Labour University.

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