The debate about bank privatisation

In the context of the future of banking in India, one of the unquestioned narratives is that of privatisation. Do some big bang privatisation of banks and everything will be alright. Government have no business to be running banks. Even the most reputed experts hold that view.

TT Rammohan takes a contrary view in a very good article on the issue of privatisation of banks. Thoughtful and balanced assessment, thinking through the entire chain of consequences associated with various actions. Also, nicely structured. 

This is a very perceptive analysis of the NPA crisis,

India’s economic boom in 2004–08 was driven by private investment, especially by private investment in infrastructure and related sectors. As the Economic Survey of 2016–17 pointed out, the boom in private investment was financed substantially by PSBs. Is it suggested that PSBs should have limited their exposure to infrastructure and allied sectors as the private sector banks did and focused instead on retail assets? Had they done so, the boom in private investment and the resultant economic boom would not have happened. Second, the problems in the five most stressed sectors have risen largely on account of factors extraneous to management. Mining has been impacted by adverse court judgments. Steel has suffered because of dumping by China and the absence of reliable fuel linkages. Infrastructure sectors such as power and roads have faced setbacks because of unforeseen delays in land acquisition and environmental clearances. Telecom was thrown out of gear by the cancellation of 2G licences. In general, projections of cash flows for infrastructure proved over-optimistic, consequent to the global financial crisis. Third, the creation of basic infrastructure is primarily the responsibility of the government. Given the fiscal constraints, the government chose to use PSBs to finance infrastructure creation by the private sector. The NPAs that have arisen—and that have necessitated recapitalisation of PSBs—may be seen as deferred financing of infrastructure on the part of the government.

And on possible reforms, 

One, we need better directors on PSB boards. The compensation of independent directors of PSBs must be raised. The RBI can lay down more stringent “fit and proper” criteria for all board members of PSBs, including government appointees. Two, the quality of appointments of managing directors (MDs) at PSBs also needs to be improved, and some improvement has already happened under the auspices of the BBB. Three, delays in the appointments of MDs and executive directors (EDs) at PSBs must be avoided through proper succession planning. The RBI can help here too by introducing penalties for undue delays in senior appointments. Four, succession planning at PSBs must involve some opportunities for internal promotion to the posts of MD and ED; all appointments do not have to be from outside. Five, variable pay for top management at PSBs can be introduced along the lines of those that obtain at PSEs. In other words, there is ample scope for improving performance within the framework of government ownership.

I'll add one more thing as a reform - ring-fence the government's use of banks for welfare initiatives by calculating its actual costs and reimbursing the differential over cost recovery. 

And as a problem, if we privatise now, given the prevailing dominant foreign ownership trend (something which Dr YV Reddy had pointed out in early 2018) in the private sector banks, we also run the risk of putting our entire banking sector under foreign control. The only major economy to have foreigners controlling its banking sector.

I have never understood the case for privatisation as a solution to the banking sector's problems or to bring in greater efficiency in them. Nor the argument that public ownership is reason for these problems and private ownership would eliminate it. There is no evidence to this effect.

Note that I am not saying privatisation itself is bad. Nor that we should have such a public sector dominated banking system.

In this context, I believe that far too often, we search for 'new' and 'big bang' solutions when all that is required to move the system from satisfactory to good is plain simple good governance - hold governments accountable for simple good governance rather than put pressure on it to try out new things.

The point is this - "hold governments accountable for simple good governance" (maximum governance). And this means merit-based appointments to executive positions in the Banks, succession planning, sagacious Board, restraint by government nominees, reimburse welfare costs, good regulatory oversight - all things TT Rammohan points out. Is anyone even talking about these things? 

Ironically, the demand for new initiatives and big bang reforms allow governments to cop out and not be held accountable on the most basic requirement for development and economic growth - good governance. Without these, given the track record of corporate India and the rising frequency of banking crises across countries, a private sector dominated banking sector will likely impose far greater costs than the present dispensation.

The argument that if governments do not have control over banks, they will not be able to do loan mela or loan waivers or force welfare programs on banks is not compelling. This is the classic argument for privatisation elsewhere - if governments do not own power companies, then there will be no free farm power, and so on. It is backed neither by evidence nor history. 

And given that the issues governments seek to address through loan melas and bank-based welfare measures will not disappear with privatisation, how are we to say that the net economic costs of those actions to address them (in a world without public sector banks) will be lower than what is the case now with public sector banks. 

The issue for discussion should not be about whether we should have public sector banks or not. It should be about the balance in distribution of the two types of banks in the country's banking landscape.