Privatisation of banks: The sequencing must be right

It would be naïve to read the recent Union Budget announcement on privatisation of two public sector banks as a signal of the government's intent to altogether exit the banking sector. That is not goi

Any discourse on the banking system in India over the last few years has been dominated by topics such as asset quality, governance concerns, frauds and scams. The last few months, however, have seen the emergence of a few other issues of far-reaching significance and this article focuses on two such issues.

The first is the recent Union Budget announcement of privatisation of two public sector banks (PSBs). It would be naïve to read it as a signal of intent of the government to altogether exit the banking sector. That is not going to happen in a hurry for a variety of reasons, as discussed further.

It was, however, nobody’s case to have a large number of banks, with hardly any distinctive features to distinguish them from each other, under the same ownership. It merely entailed duplication of efforts, resources and inefficient capital allocation. It should thus be seen as a part of the process beginning with the consolidation within the PSBs.

The case for privatisation is generally argued in terms of greater efficiency and constraints on the government’s resources for capital allocation. However, that efficiency is ownership-neutral is well established by quite a few well-operated sovereign-owned banks at home as well as elsewhere, and the myth of high governance and efficiency is also busted by the happenings in the private sector in our own backyard. On the issue of capital constraints, let us reflect on the following:

Is it possible that the consolidated banks can be considered for privatisation at this stage? Would there be a core investor passing the test to be handed over such entities of long vintage, considerable franchise and systemic importance? Unlikely. Can they be privatised directly into a widely-held ownership model? This is again fraught with huge risk if it is done before streamlining their governance framework.

It is thus obvious that privatisation, in all likelihood of two relatively smaller banks, would not immediately address either the efficiency or capital issues at the system level. However, it certainly emits long-term signals of intent and would also provide valuable real-life learnings for the future path of privatisation, and has to be seen in that context. Even this limited exercise has to strike a balance between investor expectations and safeguarding the liability franchise of these banks.

For the next steps in this journey, it would be crucial to revive the recommendations to set up a Bank Holding Company (BHC) and lay down a road map to dilute government ownership over a period of time. It would need greater reflection as to what should be the sequencing of dilution at the holding company level and entity level. This could well be a multi-year process, and if done right, can address both the governance and capital frameworks in such a way that these entities can directly migrate to a widely-held ownership model.

This brings us to the second issue — the recommendations of the Internal Working Group (IWG) set up by the Reserve Bank of India on the ownership structure of private sector banks. Without going into much detail, the recommendation to allow (i) corporate houses and (ii) large non-banking financial companies (NBFCs), including those owned by corporate houses, to migrate into banks can be reduced into a narrow entry corridor, to begin with.

Such NBFCs, which are owned by widely-held corporate houses, and/or which themselves are widely held (or would need to do so within a timeframe), should be considered eligible for such migration. They should then also be allowed to bid to acquire the PSBs being privatised, along with the others.

Thus the twain can meet in a win-win situation. 

The writer is a former deputy governor of the RBI