The legacy issues of public sector banks

Disappearance of public sector banks will be resented by the common man

On bank recapitalisation, Finance Minister Nirmala Sitharaman had this to say in her Budget speech: “Having addressed legacy issues, public sector banks are now proposed to be further provided Rs 70,000 crore capital to boost credit for a strong impetus for the economy.”  

But what are the legacy issues? The basic objective of nationalisation of banks in 1969 was to establish supremacy of the prime minister of the day in the Congress Party. That objective was well-served. 

The far-reaching consequences of that particular decision unraveled over time. It provided an extra budgetary source of immense and growing magnitude to the government, which was outside parliamentary control and not contemplated in the Constitution. The government also obtained a spread of functionaries in the states who could be used by it for a range of activities, tilting the balance between the Union and the states in favour of the Union government.  

As if this was not enough, there was a second round of nationalisation of banks in 1980. Three private sector banks that had grown in size since 1969 were nationalised. The signal was clear: Any private sector bank which tries to grow will be nationaised. That action virtually put an end to growth of private sector banking in India.  

With nationalisation in 1969, banking became a bureaucratic system that collected deposits, administered interest rates and disbursed loans as per plan priorities. Also, it became part of the broader public sector system comprising the various governments and the Reserve Bank of India (RBI). This led to the politicisation of public sector banking. The public sector banks were also used for managing fiscal stress, which, to an extent, was shifted to public sector banks and hidden there.  

The reforms of 1991 saw a new paradigm in the banking system regarding ownership, regulation and competition. First, the banking industry was opened to privately-owned banks enhancing competition, while public sector banks were expected to compete among themselves. 

Second, ownership of public sector banks became mixed, with majority ownership and control by government through statutory provisions. Red­uction in the shareholding of the government in public sector banks, however, did not dilute government’s role in governance since they are not governed by Company Law, but by relevant nationalisation legislation. Competition between public sector banks was constrained by common rules and procedures governing public sector banks. 

illustration: Binay Sinha

Third, prudential regulation and supervision by RBI was gradually oriented to global best practices.  

Fourth, the dual control of public sector banks, namely by the government and RBI was not ended, while consolidation of public sector banks took place in an adhoc manner. 

Fifth, all political formations remained — and have continued to remain — circumspect in detailing the reforms for public sector banking. Meanwhile, several private sector banks were licensed, and some of them not just survived but are thriving today.  

Finally, the policy of public-private partnership in infrastructure etc ushered in the new millennium led to liberal use of public sector banks by government to intensify crony capitalism.  

In the post 2008 crisis era, all banks in India temporarily benefited from excess or prolonged stimulus and regulatory forbearance. The farm loan waivers on a national scale also had an impact on the fiscal-public sector bank interface.  

Everyone was happy till the serious problems in the system belatedly came into the open. In 2016, it became evident that public sector banks had greater share of the problems, warranting the injection of additional capital by government. In contrast, private sector banks performed better as per standard indicators.  

The policy focus since 2016 on problems rather than solutions made matters worse. The prolonged uncertainty about the future of public sector banks has persisted. The popular perception of the efficacy of public sector banks relative to private sector banks has been replaced by scepticism, if not despair.  

The political consensus continues to be in favour of continuing with public ownership and control of existing public sector banks. The owner, regulator, the management and the large borrowers blame one another for the sorry state of these banks, while the tax payer pays for the losses. The share of public sector banking is shrinking. That is why there is budgetary support in 2019.  

Experiments by governments under several political formations in improving governance and consolidation have not yielded results so far. When capital infusion was undertaken, the conditions imposed for it could not be enforced.  

Experience shows that there are inherent limitations to enforcing conditions stipulated at the time of injecting equity. Will the Budget package of 2019 be different? What do we get out of the Rs 70,000 crore earmarked for them? Does the assurance of strengthening public sector banks include governance of these banks as well?  

From the point of view of public sector banks, the old questions remain: When will they have a board of directors that commands the trust and respect of the professionals? When will the dual control over them exercised by the government and the RBI end? When will the future of the banks and their professionals be determined by their performance rather than the uniformly applied government policies towards public sector banks?  

For the common man, particularly in rural areas, public sector banks command trust and are more accessible. Therefore, he/she would resent the disappearance or marginalisation of these banks. The policies relating to public sector banks have to consider the costs and benefits of alternatives as well. Are there similar problems with regulation and public ownership of non-bank financial institutions?

To sum it up, some legacy issues have been addressed, but several fundamental issues remain that need to be tackled. 

The writer is former governor, Reserve Bank of India