Don’t Privatize India’s Banks. Democratize Them.

By Devika Dutt

The competition for unimaginative ideas (that just so happen to privilege the power of private capital) has a new winner: the business press in India, and their calls for privatizing India’s public sector banks. Last month, Raghuram Rajan, the Governor of the India’s Central Bank the Reserve Bank of India expressed concern about a rise in the proportion of Non-performing assets in the Indian banking system. Non-performing assets (NPAs) are loans that have gone bad, are not being paid back, or are in need of restructuring. In real talk, these loans are in default. A large proportion of these NPAs are held by banks in which the majority shareholder is the government. Predictably, this has spurred a slew of articles in the business press, and many of these articles prescribe the obvious answer to all our prayers, Douglas Adam’s 42 to the Ultimate Question of Life, the Universe and Everything:  privatization.

RBI to withdraw all pre-2005 currency notes from March 31

Picture from the Press Trust of India

This kind of editorializing pulls from distorted narratives about the inefficiencies of the public sector, but more fundamentally, it misunderstands the point of state involvement in the financial sector. The Economist in particular argued that the problems in the public banking system include political interference, a lack of talent in the boardroom, and a herd mentality that encourages them to charge into the same bad bets. Sure, it may be the case that India’s largest public sector bank, the State Bank of India, just posted a 23 percent increase in profit and a decline in NPAs and has consistently done so for quite some time. Clearly, public sector banks are caving under the burden of political interference and inept management. However, it is indeed the case that things are not so rosy for other public sector banks in India. Six of fifteen public sector banks have NPAs that are higher than 6 percent of their total assets. Typically, the central government makes provisions for recapitalization of these banks in the annual budget; but in the new climate that seeks to limit state involvement, public sector banks have reportedly been told to raise equity for their capital needs, which would lower the stake of the government in these banks.

The larger point is though is that these banks are not run entirely for profits, and they should not be. Political ‘interference’ in the functioning of these banks is undeniable: tax-breaks to corporations, acquisition of land for industry and concessional loans are seen as good economic policy. These are precisely the policy measures that Prime Minister Narendra Modi took as Chief Minister of Gujarat which led to him being hailed as the messiah who could break the previous government’s economic policy paralysis. So we’re left with an odd arrangement where the very same media outlets and organization that censure the banking system for their high NPAs desire this political ‘interference’ in the first place- just the right kind of political interference.

And it is indeed the case that big industrial and infrastructural projects, for which these loans were being given, may not be profitable at the outset. Nonetheless, they are valuable for the economy.

That being said, under the garb of projects important for development, Public Sector Banks should not be pressured into making patently foolish loans to the cronies of those in power. To a very limited extent, the democratic process has prevented some of these deals. But to privatize the banking system entirely would be too huge a price to pay for this political interference. We need more democracy and transparency in our financial system, not privatization.

When public banks that serve people not profits are run democratically, good things happen like ensuring that the large population of India is increasingly being included in the financial system. Private banks do not have an incentive to extend services in remote, sparsely populated areas where the pool of income and savings is significantly lower than in cities, towns and big metropolises. Unsurprisingly, the large number of bank branches in rural areas and semi urban areas are those of public sector banks. Government schemes of social security such as pension and insurance require bank accounts. Poverty alleviation programs related to direct cash transfers, and payment of wages in India’s employment guarantee scheme, the Mahatma Gandhi National Rural Employment Guarantee Scheme, are contingent on beneficiaries having bank accounts. Without political interference, these payment systems would not have been possible.

Therefore, while rising NPAs are a cause for concern, imagine the damage that could have been done if the banking system operated only for maximizing profits. What if banks could securitize their loans and sell them? We saw very recently how indiscriminate trading in such securities, driven by the motivation of making and obscene amount of profits, turned out. Alternatively, important development projects may not have found any funding.

What, then, is to be done? To an extent transparency in the public guarantee for funding for industrial projects would allow greater democratic scrutiny, which can hopefully limit the extent to which governments can pressure banks to make loans for projects of politically powerful industrialists. As per the new guidelines of the RBI on NPAs, banks have the freedom to take a 51 percent stake in defaulting firms. This is a step in the right direction. Perhaps, we need to go a step further. For infrastructure projects, the government could acquire the controlling stake. After all, in the case of public guarantee in infrastructural projects, the state is guaranteeing that it would step in in the event of failure of the private firm to fulfil its contractual obligations. If a public guarantee is needed in the first instance, failure to fulfil obligations should come with severe penalties, such as blacklisting such firms so that they cannot receive any other public projects. This too would require public scrutiny as powerful industrialists could get off such blacklists because they have friends in the right places. In the case of private industrial projects, banks could force the sale of such firms to other firms.

In any case, these public sector banks may need recapitalization from the government so that the banking system is not jeopardized by NPAs. However, even if the economy needs greater public control, it is not necessarily a bad thing. It is not the case that public sector firms are necessarily inefficient. The profitability of the State Bank of India is a testament to that. And greater public investment or public control of defaulting firms for key infrastructural and industrial projects is not terrible either as public investment of this nature can crowd in private investment. Moreover, looking at the havoc private banks have wreaked in the global financial system, a temporarily higher government budget deficit will certainly cost us less. Okay, I admit my solution is as unimaginative as that of the wider business press. But it certainly makes more sense. In the face of the insane drive among private banks to make an obscene amount of profits at all costs, perhaps a little sense, no matter how unimaginative, is what we need.

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