50 years on, right question to ask about bank nationalisation is what next

Private banks are about to outpace the state-owned ones, but the government's job should be to deliver a financial sector where health is not determined by ownership, writes T N Ninan.

Half a century after the nationalisation of 14 banks (all those with deposits in 1969 of more than Rs 50 crore), many commentators have been debating whether it was a good or bad thing that Indira Gandhi did. That’s the wrong question, but its short answer is that it was both good and bad. It helped spread the banks’ footprint and boosted the national savings rate, but it has cost the taxpayer a pretty penny because of these banks’ constant need for fresh capital. Nor is Mrs Gandhi’s motive behind nationalisation a relevant question waiting to be settled. Everyone knows it was done for collateral political reasons, but even undisguised populism can have beneficial results. The right question to ask today is, what now?

The starting point has to be that the government-owned banks have a problem. Their lending record is much worse than for the banking system as a whole, they have been left behind in the technological transformation that has overtaken banking, and they remain less customer-focused than their better-run private sector counterparts. Even retail depositors have begun taking their money to the private banks. Losing the retail franchise could be the kiss of death.

But privatisation remains a political no-no, and in any case is not an across-the-board solution. For while private lenders like HDFC Bank have done astonishingly well, there have been failures too. The near-collapse of Yes Bank’s share price and its desperate need for fresh capital point to some of what used to go on with private banks before nationalisation. Similarly, the defaults by large shadow banks like IL&FS and DHFL, with others perhaps waiting to hit the headlines, are no advertisement for private ownership of financial entities.

That said, the government’s solutions so far have not measured up. Providing repeated rounds of fresh capital without taking steps to improve performance is not very different from pouring money into a bottomless pit. And it is not clear that the Reserve Bank has looked hard enough at its own supervisory processes, which allowed the mess to reach the scale that it has. The solution has to come from elsewhere.

Look, therefore, at what happened in telecom and aviation. The legacy players were left to stew in their own juice while new private players took away the market. No company got privatised, the sector did. Many new private entrants did not survive the competition and folded up (capitalism at work), while the government continues to own and fund the legacy players (socialism at work). By the time the government throws up its hands and finally decides to sell, there is usually precious little on offer for prospective buyers.

The banking sector is getting privatised. Just five years ago, the government’s banks used to have deposits and advances that were four times those of the private Indian banks. Now the multiple is just 2.2 for deposits and 1.8 for loans. When it comes to incremental deposits and advances, the tables have been turned dramatically. Last year the private banks took in and lent out money on a scale of two to three times what the government banks did. If private banks hold on to their role as growth drivers, it won’t be long before they in their totality become as big as the government banks, and then take over the sector.

Meanwhile, it has been true for some time that the most valuable private bank is worth much more than the largest government bank, State Bank of India. The rest of the government banks put together are worth only about as much as a private bank that wasn’t yet born in 1991. That’s because investors have made their preferences clear: good private banks are quoting at steadily higher multiples of book value, while the government ones are at embarrassing discounts to book value.

It is not enough for the government to let this process continue to its logical conclusion, because banks are more important than airlines and telecom companies. Whether through merger, selective sale, or by enforcing narrow banking restrictions on weak players, it must deliver a financial sector where health is not determined by ownership.

(Disclosure: Entities controlled by the Kotak family have a significant shareholding in Business Standard.)