Importance of Public Sector Banks

As the economy starts limping back towards normalcy, the working of the public sector banks (PSBs) is back in focus, as the banking system is central to the process of recovery and the government-controlled banks dominate the financial sector by size and volume of business. But the PSBs themselves are facing serious problems due to the large non-performing assets (NPAs) on their balance sheets. It was hoped that measures like the introduction of the Insolvency and Bankruptcy Code would help reduce the size of NPAs. However, the pandemic and consequent economic meltdown led to the central bank and the government taking steps like introducing a moratorium on repayments, loan waivers, etc., which have all exacerbated the situation.

The problem of NPAs is not a new one nor are the suggestions as to how they can be tackled. Experts often call for structural reforms in the banking sector, with an emphasis on privatization, re-privatization or bringing the government’s stake in the banks below 50%. These ideas do carry merit within the realm of financial sector management. But such proposals tend to overlook the crucial role of PSBs in the overall economic and financial structure in our country and their social importance on account of the amount of trust people have in them.

For a vast section of our population, especially the poor, the aged, the uneducated and other vulnerable sections of society, a bank means one of those nearby brick and mortar branches of a PSB into which they walk without any hesitation and where they can ‘connect’ easily. For them a private bank branch is a ‘distant’ identity for very many obvious reasons. The private sector banks (PvtSBs) mainly attract the young, the educated, tech-savvy and people better equipped to deposit substantial amounts of money and do not mind bearing high transaction costs for better ‘presentation and service’.

PSB coverage

Today, the branches of PSBs and Regional Rural Banks (RRBs) constitute 75% of all the bank branches (excluding payment banks and branches of foreign banks). Almost half of them are spread out in the rural and semi-urban areas. This geographical spread by itself contributed immensely to the inculcation of banking habits amongst the people in the interior parts of the country. The PvtSBs also now have nearly 50% of their branches in the rural and semi-urban areas thanks to the branch licensing policies of the Reserve Bank of India (RBI), which nudged banks over the years to open branches in the hitherto unbanked areas. But their preference is to establish branches in semi-urban areas.

The PSBs’ coverage of vast interiors, in spite of all their accessibility and other problems, and their basic brick-and-mortar model paved the way for people opting to open savings bank accounts in large numbers. As of end-March 2020, the PSBs had a whopping 122.50 crore of such accounts. The RRBs have 24.71 crore, while the PvtSBs have 23.80 crore accounts.

Further, these days people in the interiors also have the convenience of transacting through business correspondents (BCs) and banking outlets arranged by the bank branches, which means they need not even visit the branch for carrying out a transaction. The RBI Annual Report (2019-20) says, “IT-enabled BCs, ATMs and mobile vans have increased the outreach, scale and depth of banking services at an affordable cost.” It also says that 99% of the 491,490 identified villages across the country with a population of less than 2,000, and 94% of villages with a population of more than 5,000 have been provided with these banking services. No need to say that in all this, PSU banks have played a stellar role.

The importance and criticality of PSBs shows in the highly popular Prime Minister’s Jan Dhan Yojana (see Table).

These accounts greatly facilitate the government’s efforts at financial inclusion and the operation of the Direct Benefit Transfer (DBT) schemes of the central and state governments, under which the intended beneficiaries directly receive their dues in their bank accounts, replacing the earlier system of physical routing through third parties in which there was scope for pilferage.

Confidence in bank branches

Another major reason for the popularity of bank branches in the rural areas is that when a customer walks into a bank branch she is fully confident of doing her transaction within a known time-frame (branches normally display a chart indicating the time taken for each type of business transaction).

Further, people are aware that all banks give high importance to ‘customer service’ and the RBI keeps a close watch on the quality of customer service in the branches. RBI has also established elaborate Banking Ombudsman mechanisms at all its regional offices and a dissatisfied customer of a bank has easy access to this mechanism, which strives to resolve issues without much of a problem.

For all the above reasons, the rural population has a high regard for and belief in schemes formulated by banks that are aimed at financial literacy, deposit mobilization, loan melas (not the political ones), farmer meets, sale of subsidiary products like insurance, etc.

Nature of credit deployment

In terms of credit deployment too, the PSBs score better than PvtSBs, though in the last two to three years, the PvtSBs have expanded their credit business more aggressively. At the end of March 2020, the aggregate credit extended by the banking system in the country was around Rs.153.67 lakh crore. Out of this, the share of PSBs was Rs. 85.20 lakh crore (55.5%) and that of PvtSBs was Rs. 59.20 lakh crore (38.5%). (Foreign banks and small finance banks’ advances are also accounted for in the total credit of the system.) More relevant for the present discussion, under asset classification guidelines the ‘standard’ assets of PSBs in March 2019 were 87.8% of their assets, whereas PvtSBs were better off at 95.2%. But this should be viewed against the far greater diversity of PSB loans, encompassing agriculture, priority sector lending and large projects in critical sectors like infrastructure, power, steel, mining etc., which have long gestation periods and are exposed to multiple and complex risk factors. Understandably, the returns are low and that too not regular. PSBs have also been victims of credit decisions taken on considerations other than sound banking principles and the prevailing ‘easy credit culture’ continuously promoted by competitive politics.

As a result, the NPAs of PSBs have been alarmingly high for many years. They were 11.6% (gross) in March 2019. For PvtSBs, whose loan portfolio in retail, personal and service sectors was rapidly expanding, NPAs was not very bad at 5.3%. In such lending, there are fewer worries about gestation periods, collaterals, external influence, unforeseen risks etc. According to an RBI report, the PvtSBs lending was "relatively stress free."

Will privatization solve the problem of NPAs?

Privatization of banks, as favoured by some experts, may help bring down the NPA problem but it will obviously do so by curtailing credit to critical sectors such as agriculture, priority sector lending and infrastructure. Private managements cannot be expected to go into these problem areas. They don’t have an obligation to risk their capital in lending to these areas.

Those favouring privatization may well recall what led to the Global Financial Crisis of 2005-08. Excess liquidity caused by a lack of demand for credit for historical reasons, mainly in the US, led to sub-prime lending, that too in the real estate sector. On these weak foundations, wizards in financial engineering structured exotic derivative products that were sold to investors around the globe who were in search of higher yields. When the sub-prime borrowers started failing in payments, the whole edifice collapsed in no time bringing down many venerated institutions. Regulators were looking the other way because of their great conviction (and blind belief) that ‘free markets have the inherent capacity to guard and correct themselves’. The champions of privatization (and also globalization) just forgot that man by nature is greedy and needs to be ‘monitored’ closely in the interests of the larger society.

At the same time regulators like the RBI under governor Y.V. Reddy and economists like Raghuram Rajan (a later RBI governor) clearly saw what was coming and warned sufficiently in advance of the dangers. Reddy took a number of pro-active steps to guard our banking system from the contagion of the crisis in spite of severe criticism from many quarters.

Closer home, those talking about privatization should look at what happened to two big and important private banks last year and why there has been bad news currently about another small private bank.

Health of the financial sector

The financial sector in India encompasses banks (both public and private sector banks, regional rural banks, foreign banks and co-operative banks), the non-bank financial companies (NBFCs), insurance companies and financial institutions like the National Housing Bank. But the sector is dominated by banks with aggregate assets amounting to 75-80% of the total. Serious problems like NPAs, the nature of credit deployment amongst different sectors of the economy notwithstanding, the sector as a whole has served the economy very well.

Since nationalization, banks provided much the needed impetus to credit growth in the real sector (agriculture, industry and business). Over the years, the aggressive credit expansion of private sector banks has helped real estate, retail, consumer and personal sectors. NBFCs also entered the retail loan business in a big way. Institutions like LIC with huge funds at their disposal have become prime investors in financial assets like government securities, bonds and private sector offerings. With increasing financialization of the sector as a whole, there are worries that the real sector would suffer for want of funds in the coming years. At the same time, an increasing emphasis on financialization can lead to over-speculation and creation of exotic products to attract investors. This is exactly the scenario which led to the global crisis.

Make banking ‘boring’?

Therefore, experts like the Nobel laureate Paul Krugman favour making the banking business a boring one, meaning reducing the exciting part of financialization that aims at building up financial assets all over the globe, make short-term super gains, pay employees jaw-dropping bonuses and stock options, etc., at the cost of the real sector. Former RBI governor Reddy had given a call for going ‘back to the basics’.

It is widely believed, therefore, that the banks in public sector can be the ‘balancing factor’ to the growing influence of corporate and shadow bankers on the economy.  As the importance of the financial sector in the economy grows, it is important to have strong PSBs that have a public purpose to act as a countervailing power to the PvtSBs which are now growing in size every year.

We have a good banking structure, let us safeguard it

All said and done, we have a good banking structure, a mix of both public and private sector ones, covering all corners of the country and serving clientele of a varied nature. What is needed is more efficient management of these institutions, with less interference by powers that be, and more prudential regulation to ensure that banks go for neither ‘lazy banking’ nor ‘crazy banking’.

More importantly, we need to develop better financial conduct and discipline by all the stake holders. If the money lent does not come back for genuine reasons, the system may be able to take this in its stride, but not when huge money is pocketed by dishonest borrowers and willful defaulters as a matter of routine.

Durgananda Swamy retired as general manager from the Reserve Bank of India.