Feature: New govt rules will weaken public sector banks

Private sector banks will be able to grow their business at the cost of public sector banks

The valuation gap between public sector and private sector banks is expected to increase, if the government has its way. Recent news flow indicates a rift between the finance ministry and the Reserve Bank of India with public sector banks being at the receiving end. After opposing the government’s legislation of setting up a Debt Management Office (DMO), RBI Governor Duvvuri Subbarao has objected to the ministry issuing orders to public sector bank directly and bypassing the board.

A Business Standard report says that the finance ministry has sent letters asking banks to increase loan tenure rather than instalment amount. The ministry has barred banks from entering into non-core activities like floating insurance or mutual fund joint ventures. The ministry has also asked banks to cap the share of bulk deposits as a percentage of total deposits. Except six large banks, other banks must form consortium to lend above Rs 150 crore. And the latest diktat by the ministry is asking banks not to fund unsecured loans.

This move will help private sector players grow their business rapidly. A bank only lends money as an unsecured loan if it knows its client well and has a long relationship or if the client has a strong balance sheet with steady and visible cash flow. This move by the ministry will take away some of the best and strongest clients of a public sector bank. Normally when a corporate moves to a private sector bank for any kind of loan, the aggressive private sector player will offer a better deal for its existing loans with the public sector bank. In short, the client will be snatched away from the public sector bank in due course.

Similarly the cap on bulk deposits makes little sense, especially at a time when deposit growth is slowing on account of lesser money in the hands of retail public due to high inflation. State Bank of India in its March 2012 results had announced that it would be concentrating on bulk deposits to increase its deposit base as it felt raising money through smaller investors was tough and costly.

Most of the private sector banks have an insurance arm or a mutual fund through a joint venture or a subsidiary. If one looks at the financials of private sector banks, it is the fee collected from selling these products and other financial products as well as transaction fee that is driving growth. Normal banking operation can only earn limited profits or make losses in some cases, due to high operational costs. The ministry’s order of barring public sector banks to set up insurance or mutual fund joint ventures will only benefit the private sector players.

Public sector banks, are asked to lend to sectors which private sector players avoid, such as power, infrastructure, textile, agriculture and airlines. This has caused a substantial deterioration in their books. Further, public sector banks are the first and in most cases, the only banks in rural India as part of social responsibility and RBI guidelines.

Also, public sector banks are the only ones directly lending to farmers. Private sector banks meet their obligation of priority sector lending to agriculture sector by funding players involved in the agriculture business, like fertiliser and pesticide producers and distributors, farm equipment manufacturers among others. Rather than incentivising them, the ministry through its diktats is taking business away from them.

As has been the case with various public sector companies, be it in pharmaceuticals, telecom, engineering, or airlines, it was government apathy towards the sector which was the main cause of their failure. Will public sector banks be the new target?