Privatization of PSBs..... by Prof T T Ram Mohan

Privatization of PSBs.....

by Prof T T Ram Mohan

(Excerpts)

Those who urge the wholesale privatisation of public sector banks do not seem to have given adequate thought to the mechanics of bank privatisation in India. Given the present regulatory regime for private bank ownership in India, there are formidable obstacles to privatising even what is regarded as an obvious candidate for privatisation—the IDBI Bank. The challenges in privatising several PSBs must not be understated.

Now, we are told that the proposal to privatise the Industrial Development Bank of India (IDBI) Bank has been revived. For historical reasons, the IDBI Bank is classified as a “private bank” despite the government and Life Insurance Corporation (LIC) together owning the overwhelming share of the bank’s equity. The government now proposes to hand over a controlling equity interest to a private buyer or buyers. The attempt to privatise PSBs received a boost from academic quarters recently. In a paper presented at a recent conference, Poonam Gupta, director general, National Council of Applied Economic Research (NCAER), and Arvind Panagariya, professor, Columbia University, have argued that all PSBs except the State Bank of India (SBI) may be privatised (Gupta and Panagariya 2022). To begin with, we will show that two key assertions made in the paper that constitute the essence of the argument for privatisation are open to question.

Myth One: "PSBs' Performance POOR"

Ans: India has had recurring bouts of banking crises. True also that the government has had to bail out banks in trouble. The key question for policy is: Are banking crises unique to India and is India worse off than other economies in this respect? Not at all. An International Monetary Fund (IMF) study has documented 140 episodes of banking crises during 1970– 2011. The median cost of recapitalising banks was 6.8% of the gross domestic product (GDP). The cumulative cost of bank recapitalisation in India would be no more than 5% of GDP in the entire post-reform period of 1991–2022. The notion that the privatisation of PSBs will mean that the exchequer is no longer burdened with the cost of bank recapitalisation is misplaced.

Myth Two: "Elite Banks excel in Performance"

Ans: First, comparisons between PSBs and private banks are distorted by the fact that the comparisons do not eliminate “survivorship bias.” The PSB sample includes more private banks that have failed (25) and have got merged with PSBs than the number of private banks that failed (11) and were merged with other private banks (Ghosh and Kumar 2022). Second, the paper does not examine what factors caused PSB performance to deteriorate post 2008–09 and whether the deterioration can be ascribed to managerial inefficiency. The divergence in performance between PSBs and private banks happened after the global financial crisis (GFC) of 2007–08 and became glaring only post 2011–12. In 2010, the gross NPAs/gross advances ratio were 2.3% at PSBs and 3% at private banks. By March 2020, the position had changed dramatically: the respective numbers were 11.3% and 4.2%. The boom in lending before the GFC was the result of lending to infrastructure (power and telecom) and related sectors, namely, mining, iron and steel, textiles, and aviation. These five sectors accounted for 29% of all advances at PSBs and 14% of advances at private banks. The suggestion that such lending reflects poor underwriting skills at PSBs has been emphatically refuted by the Economic Survey of 2016–17.

The survey noted, the vast bulk of the problem has been caused by unexpected changes in the economic environment: timetables, exchange rates, and growth rate assumptions going wrong.

Let us now turn to the mechanics of privatisation. Whoever says that government should divest itself of ownership in PSBs must specify to which private hands they would like control to pass. The IDBI Bank’s travails in finding a suitor for itself highlight the issues in volved. The government sought to dilute its stake in the IDBI Bank to below 51% and to find a strategic partner instead from the budget of 2016–17 onwards. It did not have much luck. In January 2019, the LIC increased its shareholding to 51% so that the IDBI Bank became a subsidiary of LIC. The government shareholding was 45% and it has remained that way. In 2020, the LIC’s shareholding dropped to 49%. Thus, the government and LIC together hold 94% of equity in the IDBI Bank. The decision to privatise IDBI Bank was announced in February 2021 in the finance minister’s budget speech. Who are the potential buyers? A well-run private bank in India would be an ideal candidate. Alas, today no private bank has the capability or the willingness to acquire IDBI Bank. None of the four private bank leaders need IDBI Bank’s branch network,

Even if the IDBI Bank is sold at a premium to the current valuation, the government will be exposed to accusations of having got the timing wrong. The IDBI Bank, like many PSBs, sits on land and building which will have to be separately valued from the business. (At Air India, land and building were moved out to a special purpose vehicle to head off controversy.) Unions are steadfastly opposed and are much stronger than at public sector undertakings (PSUs). PSB privatisation is not the same as privatisation of non-financial enterprises or PSUs. Privatising banks is fraught with issues of financial stability. As our analysis shows, the devil in bank privatisation is truly in the detail— to what extent the RBI would be willing to dilute its carefully framed norms for private ownership in banks, norms that are intended to ensure financial stability?

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