Dear Readers, Last week, on July 19, which was the 53rd anniversary of Prime Minister Indira Gandhi nationalising 14 banks, the Indian National Congress and its senior leaders commemorated the move as "a transformational change" and bemoaned that the current Prime Minister Narendra Modi and his government were on a “privatisation spree”. Senior Congress leader Jairam Ramesh announced that his party will oppose any Bill seeking to facilitate privatisation of public sector banks (PSBs). It is expected that the government will bring legislative changes in the current session of Parliament to enable it to privatise PSBs. Finance Minister Nirmala Sitharaman had announced the government’s desire to do so in her Budget speech on February 1, 2021. “Other than IDBI Bank, we propose to take up the privatization of two Public Sector Banks and one General Insurance company in the year 2021-22. This would require legislative amendments and I propose to introduce the amendments in this Session itself,” she had stated. Indira’s bank nationalisation as well as Modi’s attempt to denationalise them evoke very sharp and bitterly polarised responses. Some claim it to be a masterstroke and others describe it as one of the biggest policy mistakes. Before reaching any conclusion, it is worth asking: Did bank nationalisation serve its purpose? Is government ownership the main reason why PSBs lag behind private banks? What would happen if PSBs were privatised? In this edition, ExplainSpeaking attempts to provide two diametrically opposite ways of looking at the issue. A Masterstroke? The Congress government had nationalised 14 banks in 1969 and then followed it up with nationalising another 6 in 1980. Nationalisation essentially meant that the government took over the ownership of certain private banks. The government's aim was to take away the control from a few private players and expand the banking coverage to rural India so that sectors such as agriculture and small industries could get better credit facilities, thus creating a new class of entrepreneurs. India was predominantly an agrarian economy at that time with very high levels of poverty (over 50%) and abysmal levels of financial inclusion. Nationalisation was seen to be the quick way to ensure all the above objectives were met; private bankers would never have expanded for such social development reasons. Cut to May 2014, the month and year when Congress was last in power. This is exactly the month and year when a committee to “Review Governance of Boards of Banks in India” submitted its report. The committee was constituted by the RBI Governor Raghuram Rajan and it was led by P J Nayak, former Chairman and CEO of Axis Bank. What the Nayak Committee found was a damning indictment of the way public sector banks were being run in the country especially when compared to the private sector ones. “The financial position of public sector banks is fragile, partly masked by regulatory forbearance…The boards are disempowered, and the selection process for directors is increasingly compromised. Board governance is consequently weak,” it declared. When the Nayak Committee reviewed what the PSB boards discussed in their meetings, they found two stark trends. One, when compared to private bank board discussions, PSB boards not only discussed fewer topics but also in much less detail. Two, that PSBs focussed less on factors such as profitability was one thing; the more surprising finding was that PSB boards even discussed development concerns (such as financial inclusion) far less than their private counterparts. Reviewing the minutes of such board meetings, this committee found several examples of PSBs focussing on irrelevant topics. Sample this: “In one bank the taxi fare reimbursement policy gets the same coverage as the NPA recovery policy”. It was routine to find PSB boards having lengthy meetings discussing things like the "details of a lecture by a bank’s CMD at a college," or the “extensive coverage of the finance minister’s visit to the bank" or the “purchase of office premises". The committee highlighted the oncoming tsunami of non-performing assets (NPAs) in PSBs and recommended the following: “The onus of remedying this situation through radical reform lies primarily with the Central Government. In the absence of such reform, or if reform is piecemeal and non-substantive, it is unlikely that there will be material improvement in the governance of these banks. This could impede the Government's objective of fiscal consolidation. The fiscal cost of inadequate reform will therefore be steep.” In the years since, the Modi government has had to repeatedly bail out one PSB after another as the NPAs rose to alarming proportions. As things stand, the current government has had to float bonds worth Rs 2.79 lakh crore to recapitalise public sector banks — that is twice the amount of oil bonds that Congress-led UPA had floated. These recapitalisation bonds will be paid by the government until 2036. The government is just the medium; eventually losses of PSBs are paid for by India’s taxpayers — both current and future. When the Economic Survey reviewed bank nationalisation in 2020, it found that every rupee of taxpayer money invested in PSBs fetches a market value of just 71 paise. This is called the market to book ratio. In stark contrast, every rupee invested in new private sector banks fetches a market value of Rs 3.70. In other words, private banks give more than five times more value than PSBs. There is another way to look at this wastage. The Economic Survey found that even if the PSBs’ market to book ratio became “equal to that of the second-worst performing” private sector bank, then the government would gain more than Rs 9 lakh crore. For perspective, that amount could fund India’s annual health budget for more than 9 years. In short, on almost all metrics of efficiency and profitability, public sector banks lag far behind their private counterparts; in the process, they have become a drain on the public exchequer. If privatising the perennially loss-making Air India was a reform, why shouldn’t the government off-load loss-making banks? A Blunder? What did nationalisation achieve? It is a valid question to ask. But answering it first requires accepting that comparing public sector banks to private sector ones is not an apples-to-apples comparison. “The key difference between the state-owned PSBs and private banks is that PSBs enjoy less strategic and operating freedom because of majority government ownership. The government exercises significant control over all aspects of PSB operations ranging from policies on recruitment and pay to investments and financing and bank governance including board and top management appointments,” states the Economic Survey. This level of government involvement cuts both ways. Public sector bank officials can be forced to extend loans when such loans don’t make economic sense. This is what Modi criticised as “phone banking” during the Congress rule. On the other hand, when things go bad — witnessed over the past decade of rising NPAs — PSB officials come under the scrutiny of agencies such as the Central Vigilance Commission and the Comptroller Auditor General. This holds them back from taking risks in lending or in renegotiating bad debt due to fears of harassment from the same investigative agencies. Moreover, apart from this starkly different institutional set-up, the central point of nationalising banks was to do what no right-thinking, profit-maximising private bank will do in the first place. If one appreciates this “social” or “developmental” objective of PSBs, the results were nothing short of transformative. Consider the following statistics from just the first decade of nationalisation: > The number of rural bank branches increased ten-fold from about 1,443 in 1969 to 15,105 in 1980 compared to a two-fold increase in urban and semi-urban areas from 5,248 to 13,300 branches. > Credit to rural areas increased from Rs 115 crore to Rs 3,000 crore, a twenty-fold increase and deposits in rural areas increased from Rs 306 crore to Rs 5,939 crore, again a twenty-fold increase. > Between 1969 and 1980, credit to agriculture expanded forty-fold from Rs 67 crore to Rs 2,767 crore, reaching 13 per cent of GDP from a starting point of 2 per cent. “This growth represents a significant correction to the undersupply of credit to farmers that drove nationalization. Both rural bank deposit mobilization and rural credit increased significantly after the 1969 nationalization,” states the official Economic Survey of 2020. The question is: Would even a fraction of this expansion been possible had it not been for the nationalisation of banks? In fact, forget the past and let’s go back to 2014. The central policy initiative of the first Modi government was the so-called “JAM Trinity”. JAM stands for Jan-Dhan, Aadhaar and Mobile number. The starting point was the Jan-Dhan bank accounts — the idea that every Indian, especially the poor, should have a bank account, which can be leveraged to bring about greater financial inclusion. The scheme was launched in August 2014. Should every Indian have a bank account? Yes, of course. But from a bank’s perspective, it may not make sense to create so many bank accounts. That’s because running each account involves a cost, and given the fact that many such accounts are likely to stay either with zero balance or dormant, the initiative would have been a non-starter had there been only private banks and no PSBs in the country. Ultimately, what bailed out the Modi government’s ambitious scheme was the fact that it owned some of the biggest banks with the widest reach and an acute inability to say no to the government. Look at the data table, sourced from the government's Jan Dhan dashboard, and note the contribution of the private sector banks in the overall achievement. 
Pradhan Mantri Jan - Dhan Yojana Beneficiaries. All figures in Crore. (as on 06/07/2022) [Source: https://pmjdy.gov.in/account] Of the total 46 crore beneficiaries, only 1.3 crores have accounts in private sector banks — that is just 2.82%. The contribution is even worse when it comes to the more marginalised beneficiary categories such as rural or female customers. That’s how much all the market capitalisation and efficiency and profitability is worth when it comes to achieving social or developmental objectives. It can be argued that if the government simply left the public sector banks alone — as in, behave like an investor and not like an owner — then these banks too would be more efficient and profitable. However, in such a regime, there will be no one to finance the government’s ambitious, even if unprofitable, policy decisions. In other words, the public sector banks are being unnecessarily demonised when the real culprit for wasting taxpayer’s money is the government and its policy choices. Which of these two arguments appeals to you more? Was bank nationalisation a blunder or would the forthcoming privatisation be one? Share you views at udit.misra@expressindia.com By the way, this week, the US Fed will announce its next policy decision about interest rates. This decision will have an immediate impact on global growth, foreign portfolio investments in India, rupee’s exchange rate, forex reserves, domestic inflation in India and RBI’s monetary policy which is due on August 5. If you want to know all these threads are connected and what is likely to happen, catch the latest episode of The Express Economist — a weekly video show — which features an interview with Samiran Chakraborty, Managing Director and Chief Economist India, CitiGroup. Stay safe Udit If you received this newsletter as a forward, you can subscribe to it, here. Do read our other Explained articles, here | To subscribe to our other newsletters, click here | 
