Why market experts are wrong about public sector banks

By Parsa Venkateshwar Rao 

In the wake of the Nirav Modi financial scam involving Punjab National Bank and the increasing rates of Non-Performing Assets (NPA) in many public sector banks (PSB), several financial experts have raised the subject of privatizing PSB’s in order to beat corporate governance issues.

These views are shared by former Chairman of Unique Identity Authority of India and Infosys founder Nandan Nilekani and former Deputy Chairman of Niti Aayog Arvind Panagaria. However, I believe that the idea of privatization as a response to bank loans is a rash and uncalculated response. Bad loans can occur in both private and the public sector, and that has been one of the key takeaways from the sub-prime mortgage crisis of the United States in 2008.

The ongoing banking crisis in India has been a result of NPAs of private borrowers, and the only thing preventing the collapse of banking institutions is that the government stands as the guarantor, especially through measures like recapitalization.

I believe there is a dire need for a more critical debate over privatization, whether it be for banks, the Indian Railways or Air India. Finance Minister Arun Jaitley has made it clear in his pronouncements in both Houses of Parliament that the government’s share in PSB’s will not go below 51%. This is the right move given policies implemented by the government for financial inclusion. Prime Minister Narendra Modi’s policy directive to open the Jan Dhan accounts as part of the drive could not have been implemented with this rigour if banks were in the private sector, due to simple lack of incentive. However, it is key to point out that there is also capitalist incentive behind this, as the success of the market economy in India relies on the inclusion of large sections of society into the institutional financial sector.

In fact, the same logic can be applied to Indira Gandhi’s decision to nationalize banks in 1969. While driven by the notion of socialist populism prevalent during the time, when we look back at the decision today, over 50 years after its implementation, the capitalist benefits are unparalleled. Banks with their adequate financial resources have been one of the main engines of growth in the open economy era of the last quarter century.

A lot of people will now argue that we have enabled banks and the banking system to grow sufficiently large for them to stand on their own, and they do not need to be propped by the government. The key question to be answered is: can they?

Private banks in India focus on chasing the expanding middle class, with their rising income and its interest in savings, investments and in home-ownership. However, these banks will never go into the rural areas or reach out to the farming sector without government prodding and backing, thus reemphasizing the importance of PSBs.

As per basic market laws in an expanding economy, the market share of the PSBs should dwindle and private banks and financial institutions should be doing more business. However, it seems that laws of the market are not working as expected in the Indian banking sector because Indians, especially those in the rural areas, the farmers and the poor, have their own way of savings and investment. The informal money-lending that takes place in villages and small-towns has not drawn the attention of the experts and the policymakers. Similarly, the functioning of the non-banking financial corporations (NBFCs), which mainly comprises the peculiarly Indian ‘chit-fund’ concept, reveal an interesting picture of how the financial system works in India.

Perhaps the genius of Indian capitalism lies in the indigenous informal banking arrangements, prevalent in pre-colonial India. There is need to give free play to the informal financial arrangements and transactions and a regulatory framework should be evolved keeping in mind the old models, giving them the capacity to evolve. Above all, there is need to look beyond the option of privatizing the PSBs, given the unique nature of the Indian market.

Parsa Venkateshwar Rao is an editorial consultant, political analyst and author of Mullah Omar and Robespierre Essays in the Politics of Ideas.