India has completed seven decades since independence, and soon, 2020 will be the golden jubilee year of the nationalisation of banks. Has public sector banking been a success? One way of answering that question is the glaring fact that in August 2014, when the government of India launched the Pradhan Mantri Jan Dhan Yojana’ (PMJDY) half of India’s poor was unbanked. That is an indictment of the public sector banking model. An authoritative study notes, “The poorer sections of society have not been able to access financial services adequately from the organised financial system.”[1] The PMJDY scheme made it easy for the poor to open bank accounts.
Attempts at financial inclusion may be traced back to July 1969 when late Prime Minister Indira Gandhi, nationalised most of the Indian banking system, which was, until then, in private hands. About 70% of the banking assets came into the hands of nationalised banks. In 1980, there was a second wave of bank nationalisation. In a study published in 2005, Robin Burgess and Rohini Pande documented that between 1969 and 1990, branches were set up in more than 30,000 rural locations and this led to rural savings rising from 3% to 15% and the share of credit to rural areas from 1.5% to 15%.[2] Former governor of the Reserve Bank of India (RBI) D. Subbarao has also said that banks would not have delivered on rural branch expansion on their own: nationalisation of banks drove financial penetration.[3]
What is notable, though, is that after the Indian government embarked on economic and financial liberalisation in 1991, less than 1,000 branches were added in rural India in the 20 years since whereas 31,181 branches came up in the 20 years between 1969 and 1989.[4] More currently, technology – mobile phones in conjunction with Aadhaar – has diminished public sector banking’s role in enabling branch access to the poor or to the remotest corners of the country.
As for the public sector banks’ role in extension of credit to industrial enterprises, it is instructive to examine the counterfactual. Had banks remained in private hands – and predominantly owned by industrialists, as they once were – access to credit would have been impossible. It was in that sense that public sector banks enabled industrialisation to a degree in the 1970s and 1980s.
Yet, they did not provide much credit to small and medium businesses (SMEs). Charan Singh and Poornima Wasadani point out that, historically, the bulk of the funding for the SMEs came from informal sources and self-finance.[5] More recently, bank credit growth to so-called ‘medium’ industries turned negative in June 2015 and has stayed negative ever since.[6] India had to create the Small Industries Development Bank of India around the start of the new millennium, and since 2014, there has been talk of creating another such bank, called the Micro Units Development and Refinance Agency (MUDRA) Bank. It is currently registered as a Non-Banking Financial Corporation with the RBI.
India has been grappling too with the problem of rising bad debts or Non-Performing Assets (NPA) in its banking system, principally in government-owned banks, since 2014. The major challenge that banks face is the share of bad assets in the overall loan portfolio which has shown no sign of peaking yet. Credit Suisse estimates that total stressed loans in Indian banking (total of recognised and unrecognised bad debts and restructured loans) constituted 17.75% of total bank loans as of March 2017.[7] It was 16.9% in March 2016. The estimate in rupee terms is 13,641 billion, which is 160.0% of the banking system capital of Rs 8,526 billion.[8]As firms in many sectors find their business models threatened by competition or by regulatory uncertainties, it becomes unviable for them to service bank loans taken.
The telecommunications sector is the latest addition to the list of stressed sectors, such as electricity generation, iron and steel and cement production. A combination of optimistic assumptions on Indian economic growth, business growth prospects, poor risk management, favouritism and fraud, have contributed to the problem of bad debts. Private sector banks too are not exempt: in fact, some of them have been pulled up for under-reporting on the extent of their bad loans.
There is a governance issue with Indian banking – both in the public and private sectors – and the government should use the banking crisis to restructure the sector in the following ways:
— it needs to hasten the recovery of non-performing loans from corporate borrowers through various mechanisms, including bankruptcy procedures;
— it must bring public sector banks under the same platform as those in the private, which are subject only to the provisions of the Companies Act besides regulation by the RBI. In other words, “all public sector banks could be converted into companies, to accord flexibility for changes in ownership, mergers, acquisitions, sound corporate governance and motivation for the workforce to compete effectively.”[9]
Since government-owned banks have been created under Acts of Parliament, they are subject to the control and oversight of the triple C – the Central Vigilance Commission, the Central Bureau of Investigation and the Comptroller and Auditor General of India. This paralyses them when making genuine commercial decisions to advance, write off or collect loans as they deem fit. “The provisions of central vigilance, CBI, etc., would be applicable to a public servant, but not to any person employed in an organisation that is substantially competing with private sector organisations; procedures similar to private sector should apply.”[10]
— The existing public sector banks have to be consolidated. The government must recapitalise the intrinsically viable institutions partially, leaving room for private funding of banks, thus diluting its share in the ones it owns. The constitution of the bank boards will automatically change. The 14th Finance Commission had suggested that there was scope to further lower the fiscal costs of recapitalisation by restricting it to the better performing public sector banks[11].
— India should avoid the universal banking model, which, in the West, became shelters that concealed risk, and thereby, sources of systemic instability. By licensing Small Finance Banks and Payment Banks, India has shown that it can create horses for courses.
There has been some smug and misplaced satisfaction in India that it avoided the worst of the 2008 global economic crisis because of its public sector banking model. But the NPA crisis should put paid to any notion that the country has a superior and more resilient banking model than the rest of the world, let alone advanced world. The nationalisation of banks was an intervention needed then for India to emerge out of poverty. Today the sector has to prepare to cater to a more prosperous India.
Dr. V. Anantha-Nageswaran is Adjunct Senior Fellow, Geoeconomics Studies, at Gateway House.
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References
[1] International Monetary Fund, Indian Financial Sector: Structure, Trends and Turns, by Mohan Rakesh and Partha Ray, (Washington, D.C.: IMF, 2017), <https://www.imf.org/~/media/Files/Publications/WP/wp1707.ashx>
[2] Aiyar, Shankkar, Accidental India – A History of the Nation’s Passage Through Crisis and Change, (New Delhi: Aleph Book Company)
[3] Ibid
[4] Ibid
[5] Asian Development Bank Institute, Finance for Micro, Small and Medium-Sized Enterprises in India: Sources and Challegnges, by Singh Charan, Kishinchand Poornima Wasdani, (Tokyo: ADBI, 2016), <https://www.adb.org/sites/default/files/publication/188868/adbi-wp581.pdf>
[6] Reserve Bank of India, Handbook of Statistics on Indian Economy 2015-2016, (Mumbai: RBI, 2016), Table 177, <https://rbidocs.rbi.org.in/rdocs/Publications/PDFs/0HANDB_F0651BA902A5244DFB75DA46261B53726.PDF>
[7] Credit Suisse, Indian Corporate Health Tracker, (Zurich: Credit Suisse, 2017), <https://research-doc.credit-suisse.com/docView?language=ENG&format=PDF&sourceid=emblast&document_id=x754328&serialid=zIxSn4xZTOJCZ921PyMcyqKWxHK%2bd2Zxu0xhtt2oXt0%3d>
[8] The aggregate figure masks the seriousness of the problem in government-owned banks. The total stressed loans in government-owned banks is Rupees 11,872 billion which is 241.6% of their capital. For private sector banks, the corresponding figures are Rupees 1, 770 billion and 49.0%. Source: ibid.
[9] Reddy, V. Y., ‘Indian Banking: Paradigm Shift in Public Policy’, speech delivered at the Allahabad Bank, Kolkata, 16 January 2002, <https://rbi.org.in/scripts/BS_SpeechesView.aspx?Id=98>
[10] Ibid
[11] Ministry of Finance, Report of the Fourteenth Finance Commission, (New Delhi: Ministry of Finance, 2014), <http://mof.gov.in/14fincomm/14fcreng.pdf>