Privatisation of banks is a great idea, and will remain so

The proposed new policy of the central government to not own more than four companies even in strategic sectors has led to speculation that public sector banks (PSB) might be privatised. Currently, there are 12 PSBs. The idea of privatising them is a good one at multiple levels, despite the recent troubles at Yes Bank.

Private banks tend to be more productive. As former Reserve Bank of India (RBI) governor Urjit Patel writes in his new book Overdraft—Saving the Indian Saver: “Revenue per employee and cost per employee between government banks and private banks imply that net revenue per employee of private banks is 50% higher compared to government banks.”

While the general impression is that private banks pay better, that is only true at middle and higher levels and not on the whole. As Patel writes: “A back-of-the-envelope calculation suggests that if government banks paid their employees on an average what private banks do, they would save Rs 38,000 crore per year.” Clearly, PSBs are overpaying for talent.

Also, PSBs have to report to two bosses -- the Department of Financial Services of the Finance Ministry, and the RBI. As the PJ Nayak Committee on governance in banks had pointed out: “For instance, in the period October 2012 to January 2014, the Finance Ministry issued 82 circulars to PSBs.” The private banks had 82 fewer circulars to deal with during that period and hence, not surprisingly, they are better run, more service-oriented and more profitable to boot, given that there is less bureaucracy at work.

The private banks are also disciplined by the stock market. Take the example of Yes Bank. The stock price of the bank was close to Rs 400 some two years ago. Once the shenanigans of its Managing Director, Rana Kapoor, started to come out in the public domain, the stock price was hammered down. It is currently at Rs 12. While the system will take its time to punish Kapoor, the market already has.

Again, as Patel writes: “A private bank CEO’s primary concern is whether s/he will be able to raise capital when the need arises.” And for this to happen, the bank needs to be properly run, with proper checks and balances so that the stock price keeps going up and whenever there is a need to raise capital, it can be done. Once its stock price was hammered, Yes Bank simply couldn’t raise capital and, ultimately, RBI had to arrange a rescue.

Alternatively, let’s take the example of Aditya Puri, the long-serving boss at HDFC Bank, who is set to retire in October. He recently sold a bulk of the shares he owned in the bank, for a cool Rs 843 crore. This was basically a reward for running the bank properly for 26 years.

This is not to say that private banks do not have their share of problems. Take the cases of ICICI Bank and Axis Bank, where there were issues. The CEOs of both banks were eased out. As Patel says: “The point is that they could be readily cautioned through their boards and even replaced by the RBI in case of large or persistent irregularities.” The RBI doesn’t have similar control over the managing directors of PSBs or their boards. The PSB boards are largely a “placeholder for sinecure to political supporters” of the party that happens to be in power.

This is also not to say that the stock market doesn’t punish PSBs for their bad performance, in terms of higher non-performing assets, the huge losses they have incurred over the years and the constant need for recapitalisation by the government. It does.

Take the case of State Bank of India (SBI), the largest PSB and, by far, the largest bank in the country. The market capitalisation of the bank currently stands at Rs 1.71 lakh crore. The market capitalisation of Kotak Mahindra Bank, which is puny in comparison to SBI, is Rs 2.7 lakh crore, because the private bank is much better run.

Clearly, there is a lot of value being destroyed in the case of SBI. But given that it is owned by the government -- and hence, by everybody -- nobody is bothered about it. This lackadaisical attitude can be seen in the fact that 90% of the banking frauds occurred in PSBs and only 8% in private banks.

Finally, given that the government owns PSBs, time and time again it expects them to lend more money quickly and stimulate higher economic growth. This creates problems of high non-performing assets.

All these problems can be avoided if the government owns fewer banks or tries to act like an investor in these banks rather than as the owner.

As Raghuram Rajan wrote in I Do What I Do: “I have a simple metric of progress here: We will have moved significantly towards limiting interference in PSBs when the Department of Financial Services (which oversees public sector financial firms) is finally closed down, and its banking functions taken over by bank boards.”

But that is unlikely to happen. The reason for that lies in the fact that the incentives are misaligned. To turn to Patel again: “Where is the fun in owning banks if control over operations, managing them and determining their regulation is not possible?”