In 2019, India completed the 50th anniversary of bank nationalization. This chapter objectively assesses the PSBs. The survey suggests solutions that can make PSBs more efficient so that they are able to adeptly support the nation in its march towards being a $5 trillion economy.
How bank nationalization was carried out?
- India's largest PSB which is currently the 55th largest bank globally, State Bank of India (SBI), was founded as Bank of Calcutta in 1806, took the name Imperial Bank of India in 1921 and became state-owned in 1955.
- The remaining PSBs in India were formed through two waves of nationalizations, one in 1969 and the other in 1980.
- After the 1980 nationalization, PSBs had a 91 percent share in the national banking market with the remaining 9 percent held by “old private banks” (OPBs) that were not nationalized.
Benefits of Nationalization
- The number of rural bank branches increased ten-fold
- Credit to rural areas increased
- A twenty-fold increase and deposits in rural areas increased
- Between 1969 and 1980, credit to agriculture expanded forty-fold
- Both rural bank deposit mobilization and rural credit increased
Significance of PSBs
- PSBs account for 70 percent of the market share in Indian banking. These investments set the stage for a modern economy in which tens of crores of individuals and businesses are entering the formal financial system.
- A vibrant banking system can support and unleash a multiplier effect.
Current status of PSBs
- PSBs continue to have a significant footprint today albeit with a market share that is less than the 91 percent share after the 1980 nationalization.
- The decline in PSB market share has been largely absorbed by “new private banks” (NPBs), which were licensed in the early 1990s after the liberalization of licensing rules that earlier regulated bank entry.
- The primary difference between PSBs and NPBs stems from the difference inefficiencies and all the consequent differences that result from the same.
The poor performance of PSBs
- Our highest-ranked bank—State Bank of India— is ranked a lowly 55th in the world and is the only bank to be ranked in the Global Top 100.
- Countries like Sweden and Singapore, which are respectively about 1/6th and 1/8th the economic size of India, have thrice the number of global banks as India does.
- PSBs are inefficient compared to their peer groups - In 2019, every rupee of taxpayer money invested in PSBs, on average, lost 23 paise. In contrast, every rupee of investor money invested NPBs on average gained 9.6 paise.
- Credit growth among PSBs has declined significantly since 2013 and has also been anemic since 2016 which has impacted economic growth.
- In 2019, PSBs’ collective loss— largely due to bad loans—amounted to over ` 66,000 crores, an amount that could nearly double the nation’s budgetary allocation for education.
- PSBs account for 85 percent of reported bank frauds while their gross nonperforming assets (NPAs) equal ` 7.4 lakh crores which is more than 150 percent of the total infrastructure spend in 2019.
- The market-to-book ratio, which indicates the quality of a bank’s governance, is 0.8 as on 20th January 2020 for PSBs while that of the average NPB is close to 4.
PSBs face many challenges such as high operating costs, disjointed process flows from manual operations and subjective decision making.
- PSBs, enjoy less strategic and operating freedom because of majority government ownership.
- There is an implicit promise of the bailout of bank liabilities which is an implicit cost to the taxpayer.
- The majority ownership by the government also subjects PSB officers to the scrutiny of their decisions by the central vigilance commission and the comptroller auditor general.
- Over 90 percent of the cases of bank frauds based on the amount involved occurred in PSBs with private sector banks accounting for less than 8 percent.
- PSB’s poor ability to rigorously screen corporate borrowers ex-ante by evaluating the prospects of the potential borrowers and the value of the collateral.
- Private information held by their corporate borrowers leads to contracting problems because it is costly to assess the solvency of a borrower or to monitor her actions after lending has taken place.
- The current flat compensation contracts of employees and the pressures from ex-post monitoring by the vigilance agencies, the bank employees of state-owned banks prefer safety and conservatism over risk-taking and innovation.
- PSBs cannot, for instance, recruit professional MBAs directly from the campuses.
The Survey focuses on two new ideas for enhancing the efficiency of PSBs that have hitherto not been explored.
- To incentivize employees and align their interests with that of all shareholders of banks, bank employees should be given stakes through an employee stock ownership plan (ESOP) together with proportionate representation on boards proportionate to the blocks held by employees.
- Creation of a FinTech Hub for PSBs- The Public Sector Banking Network (PSBN): Using FinTech allows banks to better screen borrowers and set interest rates that better predict ex-post loan performances (Rajan, 2015).
- A GSTN type of entity should be set up to enable the use of big data, artificial intelligence and machine learning in credit decisions, especially those pertaining to large borrowers.
- Apart from utilizing data from all PSBs, which would provide a significant information advantage, PSBN would utilize other Government sources and service providers to develop AI-ML rating models for corporates.
- Credit Analytics using Artificial Intelligence and Machine Learning: Analytics based on market data are quite capable of providing accurate predictions of corporate distress. Variants of such approaches appear to hold promise for both consumer loans and commercial and industrial loans.
Use of technology to check wilful defaulters:
In sum, wilful default would not be as much of a drain on an economy’s wealth if lenders could fully recover their dues from selling pledged assets.
- Geo-tagging – the process of adding geographical identification such as latitude and longitude to photos, videos or other media – can help lenders keep track of the location of assets.
- E.g the Ministry of Rural Development geo-tags MGNREGA assets and the Department of Land Resources geo-tags watershed projects.
- GPS devices, when affixed to collateralized equipment or machinery, can alert lenders if these assets are moved out of the plant.
- Electronic items that come with remote kill switches may serve lenders well if they could, say, disable a vehicular asset remotely if the borrower attempts to dispose of it or willfully defaults on the loan.
- Integrated data on collateral across all lenders in geography may be particularly useful in curbing the double-pledging of collateral.
- The risk of infringing upon the borrower’s privacy: Strong and clear policy guidelines are needed on what data may be collected, how, by whom and for how long.
The architecture and solution flow for the proposed PSBN
Financial intermediation in the private sector for social impact
- Most microfinance institutions (MFIs) started as not-for-profit institutions.
- Post-2000, while their objective remained poverty alleviation via inclusive growth and financial inclusion, MFIs moved from purely pursuing social goals to the double bottom-line approach of achieving social and financial returns.
- Some banks partnered with MFIs by lending to MFIs for on-lending the money to this segment and thereby fulfill their priority lending obligations.
With the cleaning up of the banking system and the necessary legal framework such as the Insolvency and Bankruptcy Code (IBC), the banking system must focus on scaling up efficiently to support the economy.
Also read: Growth Rebounding To 6% - Economic Survey