Finance Minister Arun Jaitley has said that the increasing overdue loans given by the banking sector pose a grave threat to the economy. The Finance Minister has done well to recognize the problem. The global economic crisis of 2008 had started from the banking sector in the United States. The banks had given huge amount of loans to the housing sector. The borrowers could not repay the loans and as a result the banks could not repay the amounts borrowed by them from depositors. This led to the entire banking sector collapse. A similar situation could emerge in India. The Finance Minister has made it clear that the Government will invest more money towards the capital of the Public Sector Banks (PSBs) so that they remain afloat and the economy does not collapse as it happened in the United States.
IT is more difficult to regulate the Public Sector Banks, because the owner and the regulator coalesce into one. The Secretary of Finance is both the “owner” of the PSBs as well as their regulator. This has led to the PSBs becoming wildhorses without any control.
The PSBs are particularly vulnerable. Reports indicate that 50 percent of the loans given by these banks have become overdue against only 20 percent of the loans given by the private sector banks. Indeed, part of the problem is rooted in the general slowdown of the economy. Businessmen have borrowed money from the banks and set up factories. They are not able to sell their products and are incurring losses, and that is why they are not able to repay the loans taken from the banks. This problem afflicts the PSBs and Private Banks equally, but more than double the level of overdue loans in the PSBs cannot be attributed to the general slowdown. There is some additional problem in the PSBs.
The Vijay Mallaya episode has brought to light the deep rot in the PSBs. Mallaya has accused the State Bank of India of providing loans even though the Bank was aware of the problems being faced by the Kingfisher Airlines. “The Bank is equally responsible,” he had said. The Secretary of the All India Bank Officers’ Associations has said that “A powerful nexus between chairmen of PSBs, auditors, Reserve Bank of India and the banks’ boards is behind the country’s total Non-Performing Assets and willful defaulters.” He could not be closer to truth.
There is a fundamental difference in the attitude of top management of Public Sector- and Private Sector Banks. The Chairman of the State Bank of India who granted the loan to Kingfisher Airlines did not lose a paisa from her salary and perks due to the loan having gone bad. She may have even made gains from the grease money paid by Kingfisher. The income of the top management of the PSBs is not necessarily related to the profits made by the PSB that he may be heading.
The situation in a Private Bank is entirely different. The incomes of the owner are directly related to the profit made by the Bank. Value of the shares of the Bank held by him would get eroded if the Bank incurred losses. His personal credibility too would go down. He would not be able to raise loans for future projects. It is for this reason that Private Banks are more diligent in giving loans and their overdue loans are less. A person familiar with the state of affairs said that Private Banks are proactive. They call up and even make visit to the office of the borrower as soon as a loan becomes overdue. Officials of the PSBs are content only sending a letter. It is more important for them to “show” to the auditors that they had taken steps to recover the loan; than to actually take the steps to recover the loan.
Indira Gandhi had nationalized private banks so that the banks would serve the poor rather than only give loans to big businesses. She nationalized the banks so that the Government could direct the banks to open branches in the rural areas. The Government was successful in securing this objective. Large numbers of branches were opened in the rural areas, but that did not lead to the banks giving loans to the poor. The credit-deposit ratio of the rural branches is about 25. This means that for every Rs 100 accepted as deposit, these branches are giving out a loan of only Rs 25. The balance Rs 75 is sent to the head offices and is given out as loan to bigger businessmen. As a result, the final impact of nationalization has been exactly the opposite of what was intended. The PSBs continue to provide loans mainly to big businesses and not the poor. Worse, the PSBs are giving bad loans and losing money. The Government is imposing more taxes on the common man to raise the money to infuse more capital in the Banks. The Banks were nationalized to serve the common man, nut the system has turned the policy around. Poor are being taxed to support corruption and inefficiency of the PSBs. This has happened because officials of the PSBs have much to gain by making bad loans.
The PSBs must be privatized, and the management of the banks must be handed over to private individuals who stand to gain or lose according to the performance of the bank. It was not necessary to nationalize the banks to get them to discharge their social responsibilities. The Reserve Bank could have cancelled the license of Private Banks if they did not open specified number of branches in the rural areas or they did not extend specified amounts to the priority sectors. The Reserve Bank failed to undertake this regulation in the seventies. Indira Gandhi tried to solve this regulatory deficit by nationalizing the Banks, but that only led us to fall from the frying pan into the fire. Previously, private banks were making good loans and not giving loans to the priority sectors. Now PSBs make bad corporate loans and still do not give loans to the priority sectors.
It is more difficult to regulate the Public Sector Banks, because the owner and the regulator coalesce into one. The Secretary of Finance is both the “owner” of the PSBs as well as their regulator. This has led to the PSBs become wild horses without any control whatsoever. The Government must focus on regulation of the banking sector. All PSBs must be privatized so that bad loans are not made and the common man is not taxed for supporting the corrupt ways of Public Sector banking officials. The choice before the Finance Minister is either to privatize the PSBs and garner monies for other necessary investments; or impose more taxes on the people to support the inefficient and corrupt ways of PSBs.
Author was formerly Professor of Economics at IIM Bengaluru