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Banking on the Government

March 15th–16th, 2021 witnessed the congregation of 10 lakh bank employees in protest and solidarity against the much-debated privatisation of two public sector banks (PSBs). Banking services such as loan approvals, cheque processing and cash withdrawals were disrupted — estimates suggest that a total of 2.01 crore cheque instruments (valued at Rs 16500 crore) were left unprocessed in Mumbai, Delhi and Chennai. It was the United Forum of Bank Unions (UFBU) — an umbrella organization comprising 9 trade unions — that blew the war horn, calling for a strike against the decision announced by Finance Minister Nirmala Sitharam during the Union Budget as a part of the government’s disinvestment plan.

Voicing concerns over employee welfare and job security that could potentially be threatened by the privatization of PSBs, the trade unions also exhibited apprehensions about the implications for the economy. They echo arguments from the classic dichotomy of public sector banks and commercial banks, suggesting that such a move would prove to be detrimental to the Indian financial landscape.

Worries precipitated by this decision date much earlier than the announcement itself since India’s long march on the road of privatisation has been in the works for years. In the banking sector itself, IDBI bank was privatised in 2019 while 14 other banks were merged in the last 4 years, foreshadowing the possibilities of further privatization. While such asset reductions are a part of the government’s strategic sales, they also stem from a cause of concern over the efficiency of PSBs.

While the public sector is not completely devoid of pressures to earn a profit, a certain level of efficiency is expected. The PSBs’ share of bad loans, as compared to that of commercial banks, raises eyebrows. Banks claim that they have been in the green — quoting a profit of Rs 1,74,000 crore. However, the bad loans valued at Rs 2,00,000 crore led to net losses. But are profits or NPAs the best measures of efficiency for PSBs?

Given that the private sector operates with a profit motive, it is but natural to use profit and loss accounts to measure the success of a commercial bank. The rise in conversation about fiscal stability also factors in the significance of NPAs in estimating a bank’s financial health. However, the measures of efficacy cannot be the same for PSBs and private sector counterparts. The mandate and role of a public sector bank is simply too different from that of a commercial bank.

Historically, PSBs have been entrusted with achieving financial inclusion, poverty reduction, increasing access to credit, and other social objectives, thereby acting as beacons of social banking. Ever since the nationalisation of the State Bank of India in 1955, PSBs have played a crucial role in acting as financial intermediaries, channelling savings (particularly from rural and suburban areas) into the economy. Doggedly pursuing social objectives, these banks have been strong drivers of the success of many welfare policies. For instance, PSBs were responsible for opening 16.5 crore Jan Dhan accounts as part of the Pradhan Mantri Jan Dhan Yojana. In contrast, private banks only opened 68 lakh accounts.

With the poor financial infrastructure post-independence, PSBs have been essential to making banking and financial services accessible in the remote regions of the country. In many ways, it is this progress in financial inclusion that has been an engine of growth by bringing unproductive savings into circulation. Tapping into the closed vaults of rural savings, PSBs encouraged saving in banks that mobilised resources and money that was otherwise stagnant. An example of the contribution of PSBs to the financial architecture is the State Bank of India that achieved 100% inclusion by covering 31,729 villages during the financial year 2014. State-owned banks also contributed to fostering an entrepreneurial environment by extending credit facilities to vulnerable groups and weaker sections that may not have the necessary collateral to secure loans in private banks.

Any bank’s greatest asset will always be Trust. Without the public’s faith in the brand and institution, a bank will never be able to garner savings and deposits. Previously, crises like the Yes Bank crisis of 2020 have raised questions on commercial banks’ ability to manage liquidity, inspiring a feeling of uncertainty in the public. With the notional commitment of the government to fiscal stability, public sector banks emerge as symbols of trust causing the general public to hold at least one account in a PSB. Hence, the role of a state-owned bank extends beyond its social obligations — it acts as a propagator and preserver of faith in the banking system for the masses.

Public sector banks also possess strategic importance for the country — they support key industries with stressed assets such as aviation, mining, iron and steel etc. By supporting these industries, PSBs ensure that certain strategic sectors of the economy are protected and preserved due to the role they play in ensuring stability, employment or the smooth functioning of the economy. Hence, the loans extended to these sectors are greater in PSBs than in commercial banks, subsequently leading to greater NPAs as well. The bad loans from these key industries, coupled with the NPAs from extending loans to vulnerable social groups, explain sufficiently why PSBs suffer from a greater percentage of non-performing assets. Are NPAs still the strongest measure of efficiency between commercial and public sector banks? Probably not.

Due to the very difference in the mandates and incentives of the private sector and public sector banks, it is folly to believe that a profit-driven, private sector bank can do what a PSB does. The strong tug of the profit-motive and responsibilities to shareholders impose a natural limit to the amount of social contribution a commercial bank can make to the economy; especially, given that many cases involve a direct trade-off between profits and pursuing social objectives. Hence, calls for privatisation of PSBs imply a simple trade between social responsibility/financial inclusion and profits, or what one might term ‘efficiency’. While the government can certainly get rid of a few bad apples in the basket by dumping poorly managed/underperforming PSBs, any economy like India should retain a certain proportion of public sector banks in the financial architecture to encourage equality, welfare, and fair access to financial services.

Whether the two banks being privatised are inefficient is a matter of economic analysis, but one must be careful with the metric being used. One can argue that the 2 banks being currently privatised still leave enough social bankers to strengthen the financial fabric of the economy, but we know which sides the trade unions will take. As we possibly head towards a more privatised, profit-driven India, the question remains — can we still bank on (read: with) the government to ensure the strength of our financial landscape?

Advaita Singh is a second year economics student at Ashoka University and is the president of the Economics Society.

How COVID-19 is adding to the existing NPA crisis in India

As described by the Reserve Bank of India (RBI), “An asset, including a leased asset, becomes non-performing when it ceases to generate income for the bank.” When banks give out loans to borrowers, these loans are treated as assets. In some instances, when borrowers stop providing interest and other payments for a period of time, banks treat these as NPAs.

Increasing NPAs burden the financial system and deteriorate the health of banks. As banks stop getting returns from these assets, their profitability is affected. Along with the negative effects on profitability, the loss rate of banks also increases. As the funds of the bank decrease, the future lending capacity of banks is heavily affected. These different events leave banks vulnerable to various unexpected events, namely economic shocks.

Now that the COVID-19 shock is in place, “The level of the NPAs is going to be unprecedented in six months from now if we really recognise the true level of NPAs. We are in trouble and sooner we recognise it, better it is because we really need to deal with the problem,” said Raghuram Rajan at the India Policy Forum in July earlier this year.

Take a look at the table below that indicates the Gross NPAs of banks from 2016-2019.

Source: Department of supervision, RBI

From the data, we can see that banks had made an overall recovery in 2019 with lower Gross NPAs compared to the previous year. This progression made by banks is now being undone by the pandemic.

Additionally, the data shows that there is a stark difference between the Gross NPA levels of public and private sector banks.

Public sector banks (PSBs) have relatively lower capital adequacy compared to private sector banks. PSBs are not efficient at managing their NPA ratios, even the technology used by these banks is not as leveraged compared to private sector banks. Another contributing factor to relatively high levels of Gross NPAs in the PBSs is the vulnerability of these banks to promote certain economic sectors of society due to political pressure.

The stabilization of PSBs and restructuring of their financial affairs is essential for the PSBs to absorb the shocks caused by the COVID-19 pandemic.

During times of an economic crisis, testing the resilience of financial institutions becomes imperative for the government to get a ground reality of the situation. Doing this helps the government understand how volatile the market is. Once the assessment is made, governments can then apply relevant reforms to stabilize the financial system.

To assess the current health of banks in India, stress tests were taken by banks under certain guidelines of the RBI. Though it was known that the results of the tests would be disappointing, they are far worse than expected. Reports show that the Gross NPA ratio of the banking sector is likely to increase from 8.5% in March 2020 to 12.5% by March 2021, or even up to 14.7%, if adequate measures are not taken. While the GNPA ratio of the PSBs is expected to increase from 11.3% in March 2020 to 15.2% by March 2021, the private sector banks are expected to increase from 4.2% in March 2020 to 7.3% by next year.

We should be extremely worried about high NPA levels as it starts a chain of deteriorating financial events. High NPAs lead to low profitability of banks. The lending capacity of banks as well as their income decreases. Additionally, since the banks are unable to increase their lending, money flow is reduced. To add to this, the confidence that the public has on the banking system is heavily impacted and shareholders start contracting their investments. Thus, the issue of rising NPAs is not just an issue that banks individually face but is an issue that impacts the financial system of the country and in turn the economy.

In an attempt to curb the financial distress caused by the pandemic, the RBI attempted to bless financial borrowers by extending the moratorium on all term loans by six months. Though the moratorium ended on August 31, the government recently announced an extension that allows for a two-year loan moratorium in the case that a borrower’s cash flow has directly been affected by the pandemic. An interest rate cut has also been issued to boost the economy.

While there is an appraisal that the new monetary policy is accommodative to the plight of the borrowers, it is unlikely that this policy is going to ease the financial burden faced by the banks. The balance sheets of banks may improve, they may gain temporary relief from the pressure caused by NPAs and even increase market liquidity by increasing the amount of money that banks may have in hand, either to invest or to spend. The fact remains that the lending capacity of banks will not improve as the amount of money flowing will remain restricted. People’s spending capacity is not going to improve for a while and even with loan extensions, it remains uncertain whether the NPAs would get converted to profitable assets in the future financial years.

Before India was struck with the COVID-19 pandemic, the banking sector already faced issues with poor health. Bad loan judgements, ineffective asset management strategies and over-relaxed lending norms have previously contributed to high NPAs of banks. For an emerging economy like India, the road to recovery is going to be a difficult process indeed. While it is imperative for banks to internally re-structure lending processes, the RBI and the government also play an important role in the strengthening of bank systems.

Shrishti is a Politics, Philosophy and Economics major at Ashoka University. In her free time, you’ll find her cooking, dancing or photographing.

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