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Privatisation of Banks

  • Posted By
    10Pointer
  • Categories
    Economy
  • Published
    15th Feb, 2021
  • Context

    The Union Budget 2021-22 has announced the privatisation of two public sector banks (in addition to IDBI Bank) and one general insurance company in the upcoming fiscal.

    It also announced a strategic sale/disinvestment policy for four strategic sectors — including banking, insurance, and financial services — in which it will have a “bare minimum presence”.

    Strategic Disinvestment:

    Strategic disinvestment would imply the sale of a substantial portion of the Government shareholding of a central public sector enterprise (CPSE) of upto 50%, or such higher percentage as the competent authority may determine, along with transfer of management control.

  • Background

    • A little more than 51 years after the14 largest banks were nationalised, the government now aims to reduce it to just four.
    • In the past, many committees had proposed bringing down the government stake in public banks.The Narasimham Committee on banking sector reforms, setup after 1991 LPG reforms, proposed to reduce the government stake in PSBs to 33%.
    • Through a series of moves over the last few years, the government is currently left with 12 state-owned banks, from 28 in 2016.
    • The two banks that will now be privatised will be selected through a process in which NITI Aayog will make recommendations, which will be considered by a core group of secretaries on disinvestment and then the Alternative Mechanism (or Group of Ministers).
  • Analysis

    Why were private banks nationalised in the first place?

    • Then-Prime Minister Indira Gandhi, who was also Finance Minister, decided to nationalise the 14 largest private banks on July 19, 1969.
    • The idea was to align the banking sector with the socialistic approach of the then government.
    • In the 1950s and 60s Indian banking sector, which largely comprised private banks, had large-scale regional and sector-wise disparity in terms of services offered.
    • Thus, Bank nationalization was done to increase financial inclusion in India's banking sector.
    • The big question is: if the banks are privatized again, will private banks repeat the mistakes of the 1960s.

    Impact Nationalisation had on PSBs

    • Banking is a highly competitive enterprise that works on profits, nationalization of banks has led to lesser competition between the public sector and private sector banks.
      • This has created a bureaucratic attitude in the functioning of the banking system.
      • Lack of responsibility and initiative, red-tapism, inordinate delays are common features of nationalized banks.
    • A liberal credit policy was incorporated to provide support to the weaker sections of the rural community. But such a policy proved harmful to the stability of the banking system.
    • Due to the lack of performance audit of banks, policy-making failed to ensure that the finance from the public institutions is going to productive uses in the larger public interest.
    • The experience of the nationalized banks has shown that these banks are now facing the problems of heavy overdue loans and economically unviable branches.
    • Given the significance of a vibrant banking system in the growth story of the nation, privatisation of banks has been proposed.

    Current issues plaguing Public Sector Banks (PSBs)

    • Compared with private banks, PSBs continue to have high non-performing assets (NPAs) and stressed assets although this has started declining.
    • After the Covid-related regulatory relaxations are lifted, banks are expected to report higher NPAs and loan losses.This would mean the government would again need to inject equity into weak public sector banks.
    • The government is trying to strengthen the strong banks and also minimize their numbers through privatisation to reduce its burden of support.
    • After 1990, when RBI allowed more Private Sector Banks, competition increased. Today, Private banks’ market share in loans has risen to 36% in 2020 from 21.26% in 2015, while public sector banks’ share has fallen to 59.8% from 74.28%.
  • Will privatization help?

    Arguments in Favour

    • Privatization will free up the government, the majority owner, from continuing to provide equity support to the banks year after year.
    • It will be another step towards reducing the fiscal deficit and financing revenue expenditure through revenue receipts in the long term.
    • This move is along the lines of minimum government and maximum governance and proactive, people-centric, people-friendly, transparent and sustainable governance.
    • Privatizing loss-making PSBs will have a deterrent effect on the staff and management of such banks.

    Arguments Against

    • According to the former Deputy Governor of RBI, Bank Nationalisation will not solve all issues and suggested that operational freedom with Government ownership may work better as it did in Western countries.
    • This would totally defeat the idea of inclusive banking as it is practiced now and was the guiding principle at the time of the nationalization of banks.
    • The past history of private sector banks tells the failure. Before 1969, all banks, except the SBI, were in the private sector. Between 1947 and 1969, 559 banks failed.
    • The government will have difficulty in providing low-cost financial services to rural and poor sections of society as the private may not like to extend its services to them.
    • The loosening of the government’s control over the economy might make the economy fragile in testing conditions.
    • With the Government announcing more and more infrastructure projects, the role of Public Sector Banks will increase.
  • Conclusion

    Privatisation of banks is not a remedy to all solutions. With steps like Privatisation of Banks, the Government should also focus on comprehensive governance reforms, resolution of NPAs and creating a free market so that investment can be reinvigorated and wheels of the economy can again get back on track.