IAS Gyan

Daily News Analysis

PRIVATISATION OF BANKS

31st May, 2022 Economy

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Context

  • The government is in the process of taking ‘advanced action’ to take forward the privatization of public sector banks and is geared up to take further steps to rein in inflation as well as maintain economic stability and growth - Finance Ministry.

Brief History of Banks in India

  • “The Bank of Hindostan”, established in 1770, was the first Bank of India which ran for about 60 years and soon failed.
  • The modern day “State Bank of India” was established in 1806 and was first named “Bank of Calcutta”. It was later renamed as the “Bank of Bengal” by the British Government. Soon this bank merged with “Bank of Madras” and “Bank of Bombay” and formed a new bank called “Imperial Bank of India”.
  • “Reserve Bank of India (RBI)” which is the central banking institution in India, was established on 1st April 1935 with the RBI act 1934. In succeeding years, India got many other private banks working well with the economy.
  • The Government of India took a step to nationalize the 14 major banks of India in 1964 after independence.
  • After the 6 years, 6 more banks were nationalized in 1970 and thus we got 20 nationalized banks in India but soon
  • “The New Bank of India” merged with the “Punjab National Bank” and now we have all over 19 nationalized banks in India.

 

Public Sector and Private Sector Banks

  • A public sector bank is a bank in which the majority of its stake is held by the Government like -SBI. The Public Sector Banks are classified into two groups as:
  1. Nationalized Banks
  2. State Bank and Associates
  • On the other hand, a private sector bank is a bank in which the majority of the shares of the bank are under the control of its share holders like the HDFC Bank and the Axis Bank. There are currently 22 Private Sector Banks working in India.

 

Privatization

  • Privatization refers to the process by which the private sector assumes operational or financial control of public institutions.
  • In other words, privatization entails the abolition of all government controls and involvement in the establishment of supply and demand mechanisms.

 

Proponents of Privatization

  • Improving efficiency has been cited as the reason for this move, it is not clear whether privatisation brings efficiency or reduces associated risks.
  • Around the world, innumerable private banks have failed, thus challenging the notion that only private banks are efficient.
  • Similarly, if private enterprises are the epitome of efficiency, the question is why do private corporate entities have such large volumes of NPAs.

 

Background: Bank Nationalization

  • Bank nationalization ushered in a revolution for India’s banking sector.
  • Before nationalization, barring the State Bank of India, most banks were privately owned and they largely benefited the rich and the powerful.
  • The nationalization of 14 private banks in 1969, followed by six more in 1980, transformed the banking sector, created jobs, extended credit to the agriculture sector and benefited the poor.
  • Areas that had so far been neglected, including agriculture, employment-generating productive activities, poverty alleviation plans, rural development, health, education, exports, infrastructure, women’s empowerment, small scale and medium industry, and small and micro industries, became priority sectors for these banks.

 

Nationalization brought equitable growth

  • The move also helped in promoting more equitable regional growth, and this is evident from RBI data.
  • The rapid expansion in branch network has been the foremost of achievements of bank nationalization. By 2020, the number of bank branches reached 1,60,827 from a mere 8,187 before the bank nationalization in 1969.Banking services also reduced the dependence on moneylendersin rural regions.
  • In rural areas, the bank branches increased from 1,443 in 1969 to 52,632 by 2020, raising the share of rural branches from 17.6 per cent to 32.72 per cent.
  • Nationalized banking improved the working conditions of employeesin the banking sector, as the state ensured higher wages, security of services, and other fringe benefits.

 

Importance of Public Sector Banks

  • PSBs are vehicles of the Indian economy’s growth and development, and they have become the trustees of people’s savings and confidence.
  • The PSBs played a huge role in making the country self-sufficient by supporting the green, blue, and dairy revolutions. They have also contributed significantly to infrastructural development.
  • Public sector banks in India are currently earning considerable operating profits, to the tune of Rs. 1,74,390 crore in 2019-20 and Rs. 1,49,603 crore in 2018-19.

 

Issues faced by Indian public sector banks

  • High Non-performing assets ratio
  • Managerial efficiency
  • Political interference
  • Poor performance of Insolvency and Bankruptcy Code and National Company Law Tribunals (NCLT)
  • High Capital to Risk-weighted Assets Ratio (CRAR): Impractical for Banks
  • Problem of high loan write-offs.
  • Willful Defaulters.
  • Corruption

 

Arguments for Privatization of Banks

Many Organizations conducted surveys and found that the privatization of the Banks will result in positive outcomes. It led the Government to re-think about the privatization of all the Banks. Let’s see why privatization of Indian Banks has become indispensable for the Government of India:

 

  • It is found that the Private sector banks are more advanced than Public sector Banks and are also working more efficiently.
  • The foreign investors prefer to invest in private sector banks rather than the public sector banks.
  • The private sector banks are much strict against loans and frauds.
  • Public Sector banks are usually less competitive than the private sector banks.
  • Private sector banks are obedient and quite serious towards their work and responsibility that is lacking in most of the Public sector banks.
  • The private sector banks follow the concept of lowest risk.
  • Privatization will also help to reduce the burden of the Government of India.
  • Privatization of banks will deter government influence & control and aids economic growth. (Lack of Political Influence)
  • Privatization attracts public investments and FDI's.

 

Arguments against Privatization of Banks

  • The privatized banks will focus on maximizing their benefit and it will put an adverse effect on the middle class and poor people of the society.
  • Every organization, whether government sector or private sector, has some issues within its structure. It is not necessary that a private sector bank will never go with any fraud.
  • The public sector banks usually work on social welfare while the motive of private sector banks is generation of profit.
  • Many government schemes like “Jan-Dhan Yojna” and “Pension Yojna” worked well and also became successful only because they were applied in Public Sector Banks.
  • Another disadvantage of privatization is nepotism which will affect the banking services.
  • Loss of Jobs: Employees are concerned that they may lose jobs due to the privatization of banks.
  • Private sector banks can exit the market at any time.
  • SC/ST/OBC categories may lose reservation benefits.
  • High service charges on transactions and other services.
  • Limited safety and security. All India Bank Officers Confederation claimed that Indian Citizens prefer safety and security of their money deposits that is offered by Public Sector Banks.
  • Power in the hands of big business houses. Greater disparities in income and wealth.
  • May result in lopsided development of industries in the country.
  • May not uphold principles of Social Justice and Public Welfare.
  • Public sector banks’ coverage of rural areas was far better than their private sector counterparts.
  • Private Banks are lagging in the deployment of rural ATMs, with 6,112 (18.34 per cent) in total rural ATMs of 33,312, as of the end 2020.
  • Private Banks can never match PSBs in the real sense, due to PSBs’ higher risk-taking capacity and the dual nature of their profitability — social and commercial profits.
  • The Nationalized Banks have bailed out the failing private banks. Twenty-five private banks were merged with PSBs from 1969 to 2020 as per AIBEA’s compilation; the YES Bank’s bailout by the State Bank of India is the latest example.
  • PSBs’ support to farming. Their outstanding agriculture credit was Rs 4,50,207 crore (86.6 per cent in total credit to agriculture) as of 2020 against private banks’ just Rs 72,893 crore (13.94 per cent).
  • Non-performing assets (NPAs), as can be seen from the Economic Survey 2020-21, are not exclusively generated in PSBs. The NPAs of private banks up to 2020 amounted to Rs 2,05,848 crore against Rs 6,87,317 crore in PSBs. The loans have become bad due to corporate customers’ default; the written-off sum of 50 corporate customers aggregates to Rs 68,607 crore. The idea, therefore, of transferring the bank ownership to the loan defaulters is not a solution.

 

Pros Of Privatization

Cons Of Privatization

It reduces the state’s financial burden by freeing it from losses of SOEs and reducing administrative size.

Lack of proper norms

It enables the government to mop up funds.

Ambiguity of objectives

It helps the government to trim the size of the administrative machinery.

Wrong timing & Wrong environment

It enables the government to concentrate more on other essentials state functions.

Lack of political consensus

It helps in accelerating the pace of economic development as it attracts more resources from the private sector for development.

Wrong labor strategies

It can lead to better business management

The problem of culture change

It can also encourage trade & entrepreneurship.

Prevalence of monopoly elements

 

Social profit comprises improving banking services accessibility in the unbanked areas and to the weaker sections of society; this type of profit is intangible and measured in terms of the increase in incomes, output and employment in the country.

The very need for nationalization arose due to the failure of the private sector in the area of commercial viability and the protection of depositors’ money, let alone social profit.

 

Plausible impact of privatization of banks in India

  • Privatization of Banks will definitely have some positives and they can also have adverse effects directly on society and indirectly on economy.
  • Placing such ahuge network of bank branches and the infrastructure and assets in the hands of private enterprises or corporate may turn out to be an irrational move.
  • Privatization of banks will be helpful in getting a better customer service. It will also affect the economy and helps in growth. Privatization of Indian Banks will remove irregularity and bring punctuality and will lead to accountability in the service. Privatization of Banks will increase the productivity of the employees.
  • But one of the most adverse affect of privatization will be the widespread economic gap. It will support the rich people of the society leaving poor behind. This concept will make poor poorer. Also the Privatized banks will mainly focus on urban areas and it will slowly diminish in rural areas of the nation.
  • It could lead to denial of convenient and economical banking services to the common man; the risks of monopoly and cartelization may only complicate the issue.

 

Conclusion and Way Ahead

  • Banks are the backbone of the economy. The Indian Constitution says “Every economic activity in the nation should be centred at the welfare of the people” but, privatization might violate this concept because Private Bank will aim at maximizing their own profit. Any large-scale privatization of public sector banks appears to be fraught with problems.
  • There is an urgent and imperative need to bring in a suitable statutory framework to consider willful defaults on bank loans a “criminal offence”.  
  • The right solution for correcting the functioning of PSBs would be putting in place better regulations and control mechanisms.
  • In the medium term, the best solution is improving governance at public sector banks.
  • Stringent measures are required to recover large corporate stressed assets, which is a key concern for the entire banking sector. This must include strong recovery lawsand criminal action against willful defaulters.
  • Willful default by large corporate borrowersand subsequent recovery haircuts, imposed through the ill-conceived Insolvency and Bankruptcy Code, has resulted in a heap of write-offs, putting a big dent on the balance sheets of PSBs.
  • This has not only affected the profitability of the banks, but has also become an excuse to allege inefficiency.
  • A system to examine top executives of PSBs across the country will also help in improving accountability.
  • But privatization of PSBs is not a definitive panacea for the problems of the banking sector in India.
  • For the country to progress, it is important to ensure that the modern banking facilities reach every inch of the country and this is possible only when operational efficiency is combined with a strong sense of service towards the nation.

 

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