Sell the best public sector banks; bids can be foreign

The Budget speech announced the privatisation of two public sector banks (PSBs). While politicians have often talked of selling losing public sector undertakings, PSBs were long taboo. They account for two-thirds of all bank credit, but have lost enormous sums through loan defaults, technically called NPAs (non-performing assets). Many were put by the RBI under “prompt corrective action”, meaning they were barred from new commercial lending because of high incompetence. Even so, an instinctive liberaliser like former finance minister Arun Jaitley opposed the privatisation of banks, saying they were useful instruments for government policy — they could be told to finance big projects for which the government lacked the fiscal means. Suddenly, the BJP has reversed its position.

This is a brave, bold decision. Yet it bristles with practical problems. Two major questions: who will bid, and which banks will be offered for privatisation? For success, the government must make an all-out effort to attract foreign banks. They have the capital required, and interest in entering a country with big growth potential.

A top private banker told me that all bidders, Indian or foreign, would be interested only in large, relatively well-run PSBs like Punjab National Bank or Bank of Baroda, not the smaller, ill-reputed ones like United Bank of India or United Commercial Bank. One reason was the difficulty in changing the poor culture and competence of the latter. Besides, even if their bad debts were formally cleared up — as is proposed by the creation of a “bad bank” that takes over all dud loans — doubts would remain whether NPAs lay hidden in their books.

Former bureaucrat Sanjeev Ahluwalia has warned that bureaucrats love control over PSBs and will try to sabotage privatisation. They will try to dispose of the small, weak PSBs rather than the big, better run ones. Yet if the aim is to significantly increase the share of the private sector in lending, and raise significant sums to cut the fiscal deficit, the big PSBs must be put on the auction block. Bank unions will go on strike, and much political stamina will be needed to see the process through.

All bidders will be required to have large balance sheets to ensure sufficient capital for banking. Many industrial houses have capital aplenty. But till now the government has, quite correctly, not allowed industrial houses to own banks, because of a patent conflict of interest. Industrialists owning a bank would give preferential undeserved loans (and later write these off) to their own industries. India’s financial system is already groaning under bad debts caused by unwise and crooked lending. The problem could worsen if industrial houses are allowed in. Currently, all private sector banks are independent of industrial houses.

But if industrial houses are not allowed to bid, who will? India’s few large private sector banks are potential bidders for the best PSBs. But their finances must be under strain. Covid has caused total non-performing loans to almost double, according to the RBI. The red ink has not yet appeared on balance sheets because of official loan moratoriums, but private sector banks must be suffering hidden pains. This will make them cautious about bidding huge sums for big PSBs. On the other hand, many foreign banks are so big and well capitalised that they could afford to be more adventurous in bidding.
India has several large non-banking financial companies (NBFCs). But many of them are run by industrial houses (such as Mahindra Finance or L&T Finance). The biggest, Bajaj Finance, is ostensibly an independent financial group but is historically linked to Bajaj Auto. If NBFCs linked to industrial houses are not allowed to bid — the current policy — no others in this category may bid.

A few months ago, an internal working group of the RBI caught analysts by surprise, suggesting that industrial houses could be allowed to get bank licences with appropriate controls to check inappropriate or crooked lending by such banks to the owners’ industrial companies. This was blasted by Raghuram Rajan (former RBI governor) and Viral Acharya (former RBI deputy governor) as a recipe for bad lending and cronyism. No matter what controls were devised, it would be difficult to check loans routed indirectly to the owners’ industries. This would increase systemic risk through over-lending to a few group companies. It would concentrate even more power in a few corporations already seen as too powerful and politically well connected.

Was the RBI working group laying the ground for allowing industrial houses to bid for PSBs? One hopes not. Much better to create conditions that make foreign banks keen to bid.

What do you think?