Taking stock of bank nationalisation

The third week of July marks two anniversaries of events in 1969, one national and the other international. The latter was the first human landing on the moon, which happened around 8 am on a Sunday morning in India. Just 12 hours before that, Prime Minister Indira Gandhi announced to the nation that the government was taking over 14 private banks and nationalising 85% of the nation’s deposits. One event was a technological breakthrough while the other demonstrated political audacity. Each has had long-term influence, one on the evolution of space exploration, and the other on the evolution of banking and finance. We will leave the story of Apollo 11, whose crew came back safely to earth, and the subsequent developments, for a later day. For now, let’s focus on the long shadow of bank nationalisation.

The economy has grown 50 times larger since 1969. The bank deposits with those 14 banks were not even Rs 100 crore then, while today Public Sector Banks (PSBs) hold over Rs 100 lakh crore in deposits. The deepening of the financial sector, its formalisation and its spread into every corner of the country has been phenomenal. After 53 years, the share of deposits with PSBs is still at 70%, which is a fall of merely 15% since that day of nationalisation.

Incidentally, Indira Gandhi had rushed through nationalisation, even obtaining presidential assent on a Saturday. But this hasty legislation was defeated by the Supreme Court just six months later, and hence a modified ordinance had to be passed to overcome the court hurdle. She gained immense popularity and political mileage from this decision since there had been hundreds of private bank failures in the previous 20 years. The public perceived, rightly or wrongly, that their money was safe in PSBs.

That feeling persists to this day. Even the Modi government has shown disproportionate dependence on PSBs rather than private banks. For instance, more than 90% of the Prime Minister’s Jan Dhan Yojana of 450 million accounts were opened by PSBs. This is the world’s foremost financial inclusion campaign and has helped channel government subsidies through direct benefit transfers to the JDY accounts. During Covid, these accounts proved helpful.

The Mudra loans to small enterprises also are mostly the domain of PSBs. On the credit side, too, the bulk of the loans for the government’s projects, whether in ports, roads or railways or other infrastructure, are through PSBs. A recent example is the Bundelkhand Expressway in Uttar Pradesh, whose estimated cost is Rs 15,000 crore. Loans for the Expressway were raised from a consortium of PSBs.

As for bank failures, there too, the PSBs come to the rescue. Yes Bank recently was de facto taken over by State Bank of India (although not technically). The ill-famed Global Trust Bank was bailed out by the Oriental Bank of Commerce back in 2004.

If one looks at only the commercial performance of PSBs, the picture is mixed, to put it mildly. The quantum of bad loans, non-performing assets (NPAs), is much worse for PSBs in comparison with private banks. A recent report by the credit information company TransUnion Cibil shows that willful defaulters, i.e., against whom the banks have initiated legal action, have increased 10-fold in the past 10 years. As of March 2021, these defaulters owed Rs 2.4 lakh crore, of which 95% of the amount was owed to PSBs. This amounts to loot of public funds.

Of these, there are 36 people who have defaulted on more than Rs 1,000 crore each. The chances of recovery are remote, and in any case, the legal process is longwinded. The question is whether this implies negligence of the lenders, lack of vigilance on the loans, or lending under some political pressure?

The negligence argument is not convincing, since for example, 30% of those loans were given by State Bank of India or its associates, who are all known for high standards of diligence and lending practices. Why is it that private sector banks have low NPA ratios? Are they better at loan monitoring? Are they better custodians of public deposits? Do they inherently take less risks? Is it because they don’t lend to socially desirable but commercially non-lucrative borrowers? Or is it because they don’t face political pressure to lend?

The view that privatising banks is the panacea for all ills of banking in India is obviously wrong. All bank failures have been of high-profile private banks. The mother-of-all bank failures occurred in 2008 in America and among the western nations, starting with the fall of the gold-plated Lehman Bank, and the domino effect resulted in a global financial crisis. Surely, public sector ownership of banks was not to be blamed for this crisis.

Around the same time, in late 2008, a cash-rich company like Infosys had to publicly announce that it was moving its cash deposits from private and foreign banks to the State Bank of India, and that its shareholders or customers should not panic!

The instinctive flight of public deposits to PSBs indicates the trust and confidence of depositors. There is, however, a flip side to this confidence. It is because of an implicit guarantee by the owner of the PSBs i.e., the Government of India, that no bank will fail. This un-priced guarantee can result in poor profitability.

Is it fair that the public depositor should have an unlimited guarantee that her or his money in the PSB is safe? Should there not be an upper limit (say, Rs 5 lakh) above which funds are at risk of bank failure? The answers to these and many such questions lie in banking reforms, which include more autonomy in their running, more commercial orientation, a lower burden of pursuing social objectives, more focus on manpower productivity, and a better pricing of depositors’ risk.

The wrong answer is outright and wholesale privatisation of all PSBs as was proposed recently in a paper authored by a former NITI Aayog chairman and a present member of the Prime Minister’s Economic Advisory Council. Surely, a middle path can be found, wherein government ownership is reduced, functional autonomy of the PSBs is increased, the public’s trust is maintained, deposit insurance is properly priced, and the commercial performance of banks is enhanced. This is not rocket science, unlike that moon-landing in 1969.

(The writer is a noted economist)

(Syndicate: The Billion Press)