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Government Looking at Massive Overhaul of Public-Sector Banks in India

Jul 26, 2020 2:46 PM 3 min read

The story began in 1969, when GoI nationalised 14 of the country’s largest private sector banks. The move, while it resulted in increased banking channels for Indians previously left out of the system, also led to a series of corruption scandals and an excess of bureaucratic red tape, thereby crippling the sector for decades.

Over the past few years, various reforms have been implemented to modernise Indian banking. These include the passage of the Insolvency and Bankruptcy Code (IBC) and the merging of several PSBs, bringing their number from 21 to 12 as of April 1st 2020.

But India’s banking sector has too many fundamental issues and plain consolidation can only go a certain distance.

A 2019 Government report on PSBs said that on every performance parameter “PSBs are inefficient compared to their peer groups”. In fact, as of January 2020, every ₹1 of taxpayer money invested in a PSB fetched a market value of 71 paise. For private sector banks, the return was five times more at ₹3.7.

So what are some of the main afflictions plaguing Indian PSBs?

  1. Asset quality: Perhaps the biggest problem is the rise in bad loans (loans that have not been repaid by the borrower). Indian banks already had $124.3bn-worth of these soured loans, equivalent to about 9.1% of their total assets, as of September 2019. The rise can be attributed to the prolonged economic slowdown pre-COVID. And the pandemic has made matters worse. Also, PSBs’ share of bad loans is higher than that of their private sector counterparts’.
  2. Competition from NBFCs and foreign banks: Private banks, NBFCs, HFCs, investment companies and foreign banks have regularly competed hard with PSBs. They have registered higher increases in deposits than their public counterparts. The popular sentiment that customer service is better at non-state-owned banks doesn’t help either.
  3. Capital Adequacy Ratio (CAR): PSBs’ CAR has been steadily declining over the years, case in point are the regular recapitalisations.
  4. Rural sector: More than half the nation’s population resides in rural areas, where the banking system is still highly informal. Here, PSBs are running at a loss due to high overheads. At the same time, GoI decisions like waiving farm loans worth thousands of crores have made matters worse for banks.
  5. Bureaucratism: No explanations needed here! PSBs are encumbered by red-tapism, long delays and lack of the dynamism seen in the private sector.


Enter, Pandemic

Now, the financial crisis in India due to the coronavirus pandemic and nationwide lockdown have triggered the need for more reforms - and structural ones at that.

GoI is thus seriously considering the proposal for a massive bank consolidation exercise, which would also be in tandem with its objective to create a few global-sized entities in each sector.

“The idea is to have four-five government owned banks,” one senior Government official told Reuters.

A number of Government committees and the RBI had also previously recommended that the number of state-owned banks should not be more than five.

It has been hinted that more mergers are not on the table, which means GoI is looking to divest its stakes in PSBs.

The first part of the plan would reportedly be to sell majority stakes in Bank of India, Central Bank of India, Indian Overseas Bank, UCO Bank, Bank of Maharashtra and Punjab & Sind Bank.


Time and Tide Wait for COVID-19

The PSB consolidation process may not happen this year due to unfavourable market conditions.

And it won’t happen overnight - it is likely to be a long-drawn and complicated process. The Government’s overall disinvestment target for FY21 is its highest ever since 1991 (when disinvestments began). But meeting this target itself would be easier said than done. Even Government officials admit that the previously stated FY21 goal is now “irrelevant”. So you can expect that it will be some time before India has only four or five state-owned banks.

Meanwhile, reports warn that PSBs’ bad loans could double and that GoI may need to pump in nearly $20bn to keep them afloat. 

So the urgency of the situation is not lost on anyone. The appetite for banking reforms was always present; the momentum for reform has finally been initiated - even if it was done as a last-minute virus-induced Hail Mary; it’s all a matter of time now.


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