Date: 30/08/2022

Relevance: GS-3: Indian Economy, Banking Sector

Key Phrases: Public Sector Banks, Private Banks, Privatisation of PSBs, Reserve Bank of India, Financial Inclusion, Corporate Governance, National Asset Reconstruction Company, Recapitalisation

Background

• 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 a section as being reflective of the banking regulator’s opposition to the privatisation of these banks.
• In this case, what was meant to stimulate a conversation around the subject has been reduced to a political controversy.

What are the advantages of Public Sector Banks over their private peers?

• As per the paper, the state-run banks are better at financial inclusion whereas their private peers are better at profit maximisation.
• The former comes better off in cost efficiency as compared to private banks.
• The public banks also help counter-cyclical monetary policy action to gain traction.
• The state-run banks have gained greater market confidence.
• Despite the criticism of weak balance sheets, data suggests they weathered shocks from the Covid-19 pandemic remarkably well.
• 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.

Who is to be credited for the above cited pros, PSBs’ Management or the Government handholding?

• Much of the above can be ascribed to the significant handholding by the government; 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 fiscal.
• 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.
• The above report noted 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 re-capitaliser 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.

What is the state of Corporate Governance in private banks and PSBs?

• The corporate governance norms for private banks came into being two years ago, 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 management’s say in the removal of chairman or directors in these banks.
• Forced mergers were another case in point.

Does the regulatory role of RBI vary in the case of PSBs and Private Banks?

• The RBI’s supervisory data reveal that it does not matter whether the bank is PSB or a Private Bank.
• Take the example of 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.

Conclusion

• 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 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.

Source: Business-Standard

Mains Question:

Q. Why are Public Sector Banks vital for the financial health of our country? (250 words).