The title of this column is actually a very fertile and active area of research in the economics and finance academic professions. The question refers not just to ownership by the government vis-a-vis the private sector, but also between private, domestic and foreign owners. Do banks perform differently depending on who is the owner? For instance, one research paper on East and Central European banks suggests that domestic private banks don’t do as well as multinational banks, especially during crisis periods. Another paper on Kenyan banks suggests that government owned banks do much worse than private owned banks. But one of the biggest banking sectors is in China, where there is virtually total dominance of State- owned banks. Research on China shows that government banks tend to be better capitalised, and in times of crisis inject capital, rather than shrink the assets and recall loans, as found in private and foreign banks in China. In India too there has been extensive research on the issue of ownership and how it affects bank performance.
Intuitively one may think that since public sector banks (PSB’s) have the sword of the three C’s hanging on their heads, i.e. CVC, CAG and CBI (or courts), they are inherently conservative in their approach. There is no punishment or penalty for not doing anything, or not taking a decision. But if a loan goes bad for genuine or non-genuine reasons, much after the bank officer has retired, he or she can be hauled up by the investigating agencies and courts. Besides if indeed the bank officer does very well, the bonus and compensation policies in PSBs don’t allow special rewards, as is done in private banks. Indeed, there is no reward by way of stock options too, which is common in private and foreign banks. The stark difference in salaries of the chief executives of India’s two largest banks, State Bank of India (SBI) which is and by far the largest, and ICICI which is private, is well known. PSB officials have also been traditionally suspected to be under pressure from government authorities to be lenient to give loans to cronies. A recent WhatsApp quip goes like this: “Behind every “successful” businessman is a Public Sector Bank”! The word “successful” is in quotes, because it is a tongue-in-cheek comment on some recent high-profile businessmen who have decamped from the country, leaving large non-performing assets in PSBs. So, it follows that the performance of PSBs is inferior to private sector banks, including foreign.
But not surprisingly the research papers on India’s banking are inconclusive about the impact of public versus private ownership. Indeed, there are metrics which show that PSBs have done better than their private sector counterparts, something which many hard-line economists may find surprising. We should also acknowledge that despite the somewhat pessimistic views about incentives and governance in PSBs, one should and need not ignore the stellar record over several decades. India’s industrialisation has been largely bank-funded, and financed mostly by domestic savings, not foreign investors. Indeed, India’s average national savings rate during 1950-65 was barely 11% of the GDP which tripled, and the average savings rate was 33% during 2000s-08. It peaked at 37 percent in 2008. Similarly, the household sector savings rate went from 7 to 24 percent over this period. Industrial investment rate went up from 12 percent of the GDP to a peak of 38 percent in 2008. The mop up of national savings across the length and breadth of the country was made possible due to the extensive network of PSBs, not private, and certainly not foreign banks. The latter confine their presence mostly to metro cities. In fact, the two largest private banks in India are also de facto foreign owned, although their network is also quite extensive like the PSBs.
The tremendous growth in mopping up savings, and credit and investment ratios of course happened post bank nationalisation. This month we note that it was fifty years ago that 14 banks were nationalised rather abruptly. On Saturday 19 July, at 8:30 pm in the evening, Prime Minister Indira Gandhi gave a speech on radio to the nation, announcing this decision. That speech, and the cabinet note and the draft bill (initially an ordinance) was prepared by Special Secretary to Finance Ministry, and eminent economist I.G. Patel. He was actually close to Morarji Desai, who had resigned just a few days ago. The PM’s speech was exactly as IG Patel wrote it, and for once with no intervention or correction from P.N. Haksar, the legendary secretary to the PM and considered by many to be her tutor and “alter ego”. It is an irony of history that I.G. Patel, who was otherwise considered to be market-friendly and pro-private sector had to draft one of the most impactful decisions of the Prime Minister in 1969.
This column will not dwell too much on whether bank nationalisation has served India well or not. The evidence is overwhelming on the positive side. In 2008, when Lehman crashed in the U.S., many large businesses moved their cash and deposits wholesale from private banks to PSBs in India. Even a company like Infosys made a public statement that it was moving its cash pile to the State Bank of India. This was at a time when there was panic, and the public and business believed that PSBs could not fail.
But just because a decision was taken in 1969, does not mean it has not outlived its purpose. A former FM in Vajpayee government had said that the time had come to reduce government stake in PSBs to 33 percent, but also retail public sector character. Since the public trusts PSBs implicitly (rightly or wrongly), it is inconceivable that India will undertake massive privatisation of banks. The best course, besides reducing stake, is to give the PSBs genuine autonomy in their functioning, put in the practice of rewards and incentives, and of course ensure plenty of competition in the banking space. That is the policy direction we seem to be heading toward, and that’s best under the circumstances.
(The writer is an economist and Senior Fellow, Takshashila Institution) (Syndicate: The Billion Press) (email:email@example.com)
- Ajit Ranade