The government must pull back now
PSU banks must clean up their act, but this requires a clean business environment
In past decades, especially between 1970 and 2000, our public sector banking system was required to help fund the development of a robust democracy in a poor country. Today, an emerging India needs a banking system that can meet the financial needs of its people and support a clean business environment. Our public sector banks (PSBS) are failing us in this.
Depositors’ money, collected through the government guarantee that PSBS provided, allowed the establishment of democracy under perilous conditions. Nationalising banks in 1969 with the rapid branch roll out thereafter helped garner the money needed to support a “full adult franchise democracy” to survive. In 1970, India was a basket case with low per capita, little access to external commercial borrowing, low tax revenues, and a poor and highly dependent populace needing government support. Bank deposits were the only substantial revenue source for plan expenditure, appeasing interest groups and funding elections.
Plan outlays were supported by government borrowing through statutory liquidity ratio (SLR) and cash reserve ratio (CRR) at over 50% of net demand and time liabilities. Political constituencies (farmers, SMES, unemployed, etc) were funded through priority sector lending at 40%. Universal adult suffrage required higher social spending compared to other countries at similar levels of development. The remaining was rationed through a credit authorisation scheme. This industrial credit allocation supported industry but was also used for election funding as bank deposits, routed as loans to industry, also funded political parties. Government ownership avoided any bank runs.
Governments understood that bank survival was the golden goose that could not be killed and so there was a cycle of pillage and recapitalisation which had an eight-to-12 year cycle. The crisis in 1998 was cleaned up by 2006 and the pillage starting thereafter got recapitalised in 2017. Can we change this paradigm today? I believe we can. An India with a $107 per capita in 1969, needed bank deposits in a way that it does not at a per capita of $1,710 with all its accompanying changes in terms of tax revenues, FDI attractiveness, liquid capital market, stronger and larger private sector banks. Over the last 17 years, India quintupled its economy to $2.2 trillion. It is the highest recipient of FDI last year; with GST, its tax base is broader; CRR and SLR are much lower; and political funding can be done directly by electoral bonds.
India’s share of global GDP has risen in the last four years from 2.4 to 3.1%, and India’s n growth added 21% to the global growth rate. In this positive overall story the one thing that affects India adversely is the twin balance sheet problem that arose due to bad loans and the charge of poor ethics in business. The recent Nirav Modi fraud reminds us that the ₹2.11 trillion recapitalisation has not solved the problems afflicting PSBS. These scandals affect India’s image globally and when they happen they choke credit to industry. The time has come where a new confident India needs an ethical business environment which will be better served by a different banking structure.
The pathologies in PSBS have been well documented. They suffer from poor governance (ownership and direction from govern- ment, weak boards, poor CEO appointments and interference) inhibiting oversight (from CVC and CBI) and constrained HR rules. The moot question is: do we still need 20 majorityowned government banks today?
I believe the State Bank of India can remain majority government-owned because of its size and importance, but it should be provided even more autonomy and freedom. For all other PSBS, the government should comply with the RBI regulations for private bank promoters and bring down its stake to 15% (required of private promoters in 12 years), with no other investor being allowed to own more than 5% stake (this will not dilute any depositor confidence in the bank but will relax the constraints in governance, oversight and HR policies that currently inhibit performance). As a concession, the RBI may even allow the government to hold 26% in PSBS but the government should consider whether it wants 20 or, say, four banks, and divest its stake in the others. In all of this I don’t have problems with mandated government interventions in the entire banking sector, but disapprove of discretionary interference, easy with individual PSBS.
India does not need depositor money to sustain its democracy today. What it needs is to root out the last vestiges of unethical capitalism which plagues its business environment. A banking sector, in which PSBS (with government as their largest owner) are unconstrained and can perform, will take us on the path of a clean and dynamic $5 trillion economy faster. The time has come to do it.