In today's Finshots we see the debate surrounding bank privatization

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The Story

On 19th July 1969, as the world waited with bated breath for the first humans to land on the moon, India was busy dabbling in a historic event of its own — setting the wheels in motion to nationalize 14 commercial banks across the country. In one extraordinary move, the government took over private-owned banks in India that accounted for nearly 85% of the country’s deposits.

But 50 odd years later, the government may now be set to reverse that decision. Yes, there are rumours suggesting that the government may privatize all public sector banks soon and we need to talk about it. Now obviously, this won’t happen overnight. And one could argue it may never happen at all. But the government has indicated in the past "they have no business running a business." So there is a case to be made that a privatization drive may be right around the corner.

But before we dive into this matter, let’s rewind a bit to see why banks were even nationalised in the first place?

In three words — private bank failures!

You see, a whopping 665 private banks failed in the period between 1947 and 1969. And people began losing faith in the country’s banking system. And private banks weren’t exactly aiding the banking cause in a big way either. They weren’t granting enough loans to farmers, they weren’t sanctioning credit lines to small industries and generally, they were ignoring a large part of rural unbanked India. And so the government stepped in to bridge the gap.

However, things are very different now. Especially since the liberalization reforms of 1991.

The private sector came through in a big way while PSBs languished. Their market share dropped to 60%. But more worryingly, the spate of bad loans grew with some of the biggest defaults rocking the space. For instance, you had the jeweller Mehul Choksi fleeing the country after he defaulted on a ₹13,500 crore loan. Then there was the diamantaire Nirav Modi who got away with fraudulent credit worth ₹14,000 crores, and of course the famous case of liquor baron Vijay Mallya who is accused of defaulting on loans worth ₹9,000 crores. And the common thread tying these separate incidents? Public sector banks. They were the biggest lenders in most of these cases. And as a consequence of the poor decision-making, the government had to infuse ₹3.10 lakh crores in the last 5 years to keep these banks afloat.

It was a black hole. One that sucked taxpayer money by the billions.

So you can see why the government wants to privatize these banks and wash their hands off these mammoth institutions.

But the only problem with this argument?…Bad loans and corporate governance isn’t just a PSB problem.

Remember Yes Bank?

That was a private sector bank that capitulated in a spectacular manner. And if Yes Bank seems like a minor hiccup, do you remember ICICI Bank? A few years ago the former CEO was accused of extending loans worth nearly ₹2,000 crores to a corporate house that had business links with her spouse.

And lest we forget, several private NBFCs have gone under, because they weren’t prudent enough. So privatization alone won’t solve the banking quagmire.

And there’s something else that we haven’t considered here at all. PSBs have a distinct social agenda.

First, there’s financial inclusion.

PSBs make up nearly 85% of the total rural branches in the country. And it enjoys a similarly share when it comes to ATM deployments in these areas. They reach people in the most remote corners of India. The private sector would never go here because it would be an entirely loss-making proposition.

Then there’s the role it plays in social welfare schemes like the PM Jan Dhan Yojana. Overall, the scheme has aided the opening of over 44 crore bank accounts, but private sector banks contributed a measly 3% to this figure. Don’t forget that these bank accounts play a vital role in helping people access subsidy benefits from the government as well.

Finally, there’s also employment. Over the decades, PSBs have also been a strong source of employment with lakhs of Indian youth vying for a coveted “bank job”. But just the recent spate of consolidation of PSBs (from 27 total institutions in 2017 to just 12) has effectively shuttered nearly 3,000 branches. And the number of employees has also dropped — from 8.5 lakhs in 2017 to 7.7 lakhs in 2021. There’s also the trust deficit with private institutions. People still prefer putting their hard-earned money in a bank that is backed by the government.

So while the government might want to profess “the government has no business to be in business”, things aren’t always that black and white.

Which means we have to ask — what’s the solution to this big debate on bank privatization then?

Well, it’s tough to say for sure. Maybe we need to experiment a little and let the data decide. As former RBI governor Raghuram Rajan wrote in the book What the Economy Needs Now,

“There certainly is a case to experiment by privatizing one or two mid-sized public sector banks and reducing the government stake below 50 per cent for a couple of others, while working on governance reforms for the rest. Rather than continuing a never-ending theoretical debate, we will then actually have some evidence to go on.”

Until then…

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