Banking contradictions

The new government's reluctance to lose control over the public sector banks is nothing new "" the previous administration too had made it clear that the "public sector character" of these banks would continue, although it was willing to lower the government stake in these banks to 33 per cent.

At first glance, there doesn't seem to be much of a problem with that stance. The last few years have seen tremendous strides made by the public sector banks towards cleaning up their balance sheets and increasing their net worth.

This has been made possible by the sharp drop in interest rates, which has delivered windfall profits to banks who sold their investments at a fat profit. The surplus has been sensibly used to make provisions and write off non-performing loans, on the one hand, and to improve their capital adequacy ratios on the other.

Going forward, however, the way ahead is not so smooth. Interest rates have bottomed out and will start rising once corporate investment picks up. The first signs of that trend are already visible in the FY 2004 results.

As a BS Research Bureau study shows, private banks have seen a much lower growth in profits last fiscal compared to FY 2003, and this is mainly on account of lower treasury income. The same trend is visible across the banking spectrum.

Indeed, if only the fourth quarter results are considered, treasury income has diminished substantially. The banking sector will therefore have to re-orient its policies to pay far more attention to lending, rather than rely on treasury income to fatten the bottom line. In short, there is now no alternative for banks but to lend.

With many companies firming up plans for capital expenditure and with the continued focus on infrastructure, banks should have plenty of avenues to increase lending. However, more lending also implies the need for more capital, and the public sector banks will therefore, sooner or later, be forced to tap the capital markets.

And since the government does not have the resources to subscribe to the banks' capital issues, the net result is a dilution of the government stake. This line of reasoning was, in fact, the original rationale for agreeing to bring down the government's stake in public sector banks to 33 per cent.

More importantly, it is well-known that bureaucratic management styles in public sector banks hamper innovation and restrict the capacity for risk-taking. That is why the new private sector banks, with their superior management culture, have been able to increase their market share so rapidly, and take the maximum advantage of new opportunities in retail banking and in loan securitisation.

The public sector banks are also hampered by their wage structure, which is virtually an invitation for the private and foreign banks to poach their best talent. It's also not true that privatisation will dilute mandated lending "" even private banks have to follow the norms in this regard.

In short, privatising the public sector banks will unlock value for the government, help these banks become world-class, and at the same time ensure that banking policy remains in government hands. The only people who will benefit from a blanket ban on bank privatisation will be the bank trade unions.