Proof of concept: Govt should consider a test case for bank privatisation

The state-controlled section of India’s banking sector continues to be a major problem for policy makers. Not only is its slow credit growth delaying the revival in private sector investment, which is crucial for the economy’s return to a higher growth trajectory, but also recent revelations about allegedly fraudulent letters of undertaking (LoUs) being issued to companies controlled by jeweller Nirav Modi have highlighted the continuing problems with governance in these banks. No argument, practical or theoretical, can be made now for such a large proportion of India’s banking sector to be in the hands of the government. There has been little improvement in their functioning despite the introduction of various mechanisms aimed at improving governance in these banks and reducing their tendency towards poorly judged or outright fraudulent lending. The most recent, the Banks Board Bureau, is noticeably absent at this time of crisis, partly because the government seems to have forgotten about taking it seriously. It is ever more clear that privatisation of public sector banks is the only logical way forward.

 
Yet there are many barriers to a programme of privatisation. For one, the political risks are considerable for any government. In addition, the banks themselves will be unpalatable acquisition targets for any private sector entity. Many of them have books burdened with bad loans. This reduces their value. The government will naturally not receive a good price for them, opening itself up to attacks from the political opposition — in some cases, it could be fortunate if it received any price at all. It is also worth noting that many of the banks are vastly over-staffed or staffed by employees with low productivity. This excess employment cannot be easily shed by any acquirer. Bank unions continue to be powerful and obstructive. They also have political influence. Any programme of wholesale privatisation will have to deal with a combination of low valuations, a shortage of buyers and an aggressive campaign of obstruction by bank employee unions and Opposition parties. These are, no doubt, part of the reason that, in spite of general exasperation over frequent bailouts of public sector banks with taxpayer money, there has been no movement towards a policy of privatisation.

 
There is, however, one way to break this impasse. The government could select one of its weakest banks as a test case for privatisation. In fact, this could be sold as a special case of privatising a public sector bank that has conspicuously failed to perform; and since it will be a special case, political opposition to the move could be muted. If this bank performs well, the positive example could open the door to further privatisation in future. Demand for erstwhile public sector banks might build up among possible acquirers, leading to the discovery of more remunerative prices. Each additional privatised bank will buttress the argument, reducing opposition and increasing demand further. This virtuous circle can be set in motion by the privatisation of a fairly small and poorly performing public sector bank. It is well beyond time for the government to at least begin the process of privatisation, even if it has to do it in stages.