An article in the current issue of RBI Bulletin argues for a gradual approach to privatization of public sector banks, and warns against sudden, wholesale privatization. This advice is based on research that has found that public sector banks (PSBs) contribute more to financial inclusion and counter-cyclical lending, leading to more effective transmission of monetary policy. The paper also cites greater public confidence in the depositing public in public sector banks than in private sector banks.
Bank unions and some other organizations that see the departure from the status quo as a sell-off to vested interests may feel right from such a finding from within the central bank, given the reports and recommendations and several previous governors have been doing for decades. Making a case for privatization of PSBs. , Does the advice reflect the position of the RBI or the government? Probably not, given that Finance Minister Nirmala Sitharaman has said in her speeches on the floor of Parliament while presenting the Union Budget that the government will privatize public sector banks.
We would urge the government to continue with the process of gradual privatization of the bank. Furthermore, we suggest that this debate about ownership only serves to divert attention from the real reforms that India’s banking urgently needs: better supervision and regulation; Better use of information technology and analytics; a vibrant credit market as a complement and competition to traditional bank credit; And finally, a resolution framework for banks that fail, whether in the public or private sector. The goal should be to create an institutionally stable operating framework for banks that makes the nature of ownership irrelevant to the way banks function.
The basic function of banks is to channelize the savings of the public to those who will minimize the risk and put them to optimum use as debt capital. In this process, a bank makes savings deposits; bridges the gap between how long individual depositors want to keep their money in the bank and for how long borrowers want credit; and avoids high-risk borrowers altogether, while striking the right balance between risk and reward in the loans made by it, to generate good returns for depositors and the bank’s own shareholders.
Banks must attract deposits; develop expertise in the mix of activities for which borrowers seek loans, in order to assess risk and reward in negative loans; develop risk management expertise and debt recovery expertise; Manage funds that await long-term deployment to generate whatever returns are possible; And banks must comply with regulations designed to remain solvent, reduce deposit risk and meet social goals.
Practice is more messy. Borrowers submit cost-increased projects and bribe the decision-makers at the bank or those who hire them, ignoring minor flaws that cause the loan to fail. Bankers lack solid credit-taking skills or the incentive to motivate themselves to optimize lending. Some borrowers are not able to service the loan for reasons other than fraud. Banks must generate substantial returns without accumulating such bad loans or eating into their risk capital, and take steps to recover whatever may be left over from the bad loans. The government sets social goals that cannot be met without substantial spending on the part of the banks, without compensating the banks for that expenditure.
The narrative suggests that a major problem with public sector banks is that their decision-making is constrained by pre-emptive suspicion of criminal intent, leaving bankers at the senior-most level to take the risk if a loan turns sour. without any beneficial incentive for Former governor Urjit Patel in his book ‘Overdraft: Saving the Indian Saver’ challenges this notion after stepping down from RBI in his excellent analysis on why banking crises occur from time to time. He argues in the book that PSBs are not unduly concerned about the possibility of doubts, inquiries and investigations on the size of loans for struggling corporates (due to the perpetuity of loans). Service efficiency is reduced.
It also implied, if not explicit, the expectation that borrowers should expect different behavior based on the proximity of their powers. Private sector banks do not face such hurdles. In order to more closely align their lending practices with the social objective set by the government, something can be done that does not at the moment – an argument is made as to why public sector banks should remain owned by the government. Should – can be done. Former governor Raghuram Rajan argued for privatization, arguing that private sector banks can be compensated by the government for the efforts made in meeting social obligations. The government does not need to be the owner of the banks to serve this purpose.
Today, technology allows bankers, auditors, supervisors and regulators to access and analyze data on a scale that could not have been anticipated when the current banking rules and regulatory norms were drawn up. That potential should be used to elevate the quality of bank administration, supervision and regulation to a standard that makes ownership irrelevant to the functioning of the bank, as well as the fraud committed by diamond merchant Nirav Modi at Punjab National Bank. except to finish. Account aggregators leverage the concurrency layer enabled by the India Stack set of Application Programming Interfaces (APIs) to consolidate company financial data scattered across various entities, including the banks they deal with and the companies they deal with. Goods and Services Tax Network. Buy and sell with a real-time testament to company goodwill, far better than annual reports. They are just a start.
Assorted fintech startups that provide data analytics or operate as neobanks specializing in specific areas such as education or healthcare can enhance the quality of banking when they act as partners of commercial banks. Risk mitigation instruments, such as derivatives and contingency bonds—in addition to bank capital, Tier 1 loss-absorbing capital, disaster bonds that omit interest and repayment of principal, if a specified disaster occurs, banks’ necessary to fulfill their role. financial system. This demands a vibrant credit market.
A credit market is also needed to free banks from lending for infrastructure projects, which causes severe asset-liability mismatches for banks, and for loans made for infrastructure projects in their early stages. to secure.
Bank reform requires comprehensive reforms in the banking and financial systems, of which banks are an important part; It is not determined by the nature of ownership.
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