Privatization of Banks

Context: In the Union Budget 2021-22, the government announced its decision to privatize public sector banks and general insurance company.

Background:

The government decided to nationalize the 14 largest private banks in 1969. The idea was to align the banking sector with the socialistic approach of the then government.
State Bank of India (SBI) had been nationalized in 1955 itself, and the insurance sector in 1956.
The current steps of privatization, along with setting up an Asset Reconstruction Company (Bad Bank) entirely owned by banks, underline an approach of finding market-led solutions to challenges in the financial sector.
Presently, India has 22 private banks and 10 small finance banks.

Reason for Privatization:

Degrading Financial Position of Public Sector Banks:

Years of capital injections and governance reforms have not been able to improve the financial position of public sector banks significantly.
Many of them have higher levels of stressed assets than private banks, and lag the latter on profitability, market capitalization and dividend payment record.

Part of a Long-Term Project:

Privatization of public sector banks will set the ball rolling for a long-term project that envisages only a handful of state-owned banks, with the rest either consolidated with strong banks or privatized.
This will free up the government, the majority owner, from continuing to provide equity support to the banks year after year.

Strengthening Banks:

The government is trying to strengthen the strong banks and minimize their numbers through privatization to reduce its burden of support.

Recommendations of Different Committees:

Many committees had proposed bringing down the government stake in public banks below 51%:

The Narasimham Committee proposed 33%.
The P J Nayak Committee suggested below 50%.
An RBI Working Group recently suggested the entry of business houses into the banking sector.

Performance of Private Banks:

Rising Market Share:

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%.

Better Products and Services:

Competition heated up after the RBI allowed more private banks since the 1990s. They have expanded the market share through new products, technology, and better services, and attracted better valuations in stock markets.
HDFC Bank (set up in 1994) has a market capitalization of Rs. 8.80 lakh crore while SBI commands just Rs. 3.50 lakh crore.

Issues with Private Banks:

Governance Issues: Industrial Credit and Investment Corporation of India (ICICI)Bank MD and CEO was sacked for allegedly extending dubious loans.
YES Bank CEO was not given extension by the RBI and now faces investigations by various agencies.
Lakshmi Vilas Bank faced operational issues and was recently merged with DBS Bank of Singapore.

Under-reported NPAs:

When the RBI ordered an asset quality review of banks in 2015, many private sector banks, including Yes Bank, were found under-reporting NPAs.

Way Forward

In order to improve the governance and management of PSBs, there is a need to implement the recommendations of the PJ Nayak committee.
Rather than blind privatization, PSBs can be made into a corporation like Life Insurance Corporation (LIC). While maintaining government ownership, this will give more autonomy to PSBs.

Previous Year Question

Q.1) With reference to the governance of public sector banking in India, consider the following statements: (2018)

Capital infusion into public sector banks by the Government of India has steadily increased in the last decade.
To put the public sector banks in order, the merger of associate banks with the parent State Bank of India has been affected.

Which of the statements given above is/are correct?

Sign Up To Receive Regular Updates