PSB Privatisation Bill isn’t a magic wand

Summer of ‘69 will remain Bryan Adams’ evergreen hit. It was also a year which went down as a watershed year in the history of Indian banking. A few pen strokes resulted in 14 private banks coming under the Indian government’s fold. The exercise was repeated in 1980.

Fifty years have gone by, and the thought process around the benefits of having nationalised banks has thankfully changed dramatically. The clock may now be turned back with the government looking to table the PSB Privatisation Bill, in the upcoming Monsoon Session of Parliament, which aims at giving a push to privatising nationalised banks.

The Privatisation Bill is expected to set the stage for the government to reduce its stake in PSBs to less than 51 per cent and hand over control to the incoming investor. With over ₹3.1-lakh crore of taxpayers’ money poured into PSBs from FY17 to FY21 in the form of fresh capital to shore up balance sheets, the government’s urgency to privatise some of the PSBs is understandable. Therefore, if the Bill is implemented in the manner proposed, credit needs to be given to the government for rightly identifying the impediment in privatisation and attempting to address it.

But while the intent behind reducing government ownership in banks is reformist, any privatisation plan is contingent on one key factor — finding a suitable buyer or buyers. One of the key learnings from the ongoing sale of IDBI Bank is that an interested investor is willing to bring money to the table only if there is a firm commitment from the government that there would not be any interference in the bank’s operations or management after the sale. Essentially this would mean the government giving up not only its controlling stake in a bank, but also its seat at the table.

In a bid to please markets, are the scale, size and complexities of PSBs being ignored? There are two main aspects to consider in the process of bank privatisation. Is the Indian private sector deep-pocketed enough to buy up PSBs? Do they have what it takes to run a bank with a balance sheet upwards of ₹1 trillion?

The scale problem

First, there’s the question of valuation. Take the case of State Bank of India. While SBI trades at its book value, other PSBs remain at a steep discount to their book. Essentially this suggests that despite these banks being back on track and posting healthy net profit in FY22, the Street isn’t willing to value the progress made just yet.

Majority of the PSBs including Indian Bank, Bank of Baroda, Bank of India and Union Bank trade at 0.3 to 0.7x their FY23 book. What this means is that the market is unwilling to take the net worth of PSBs at face value and expects a dent due to asset quality risks.

Therefore, every ₹100 of capital infused into a PSB is valued at a fraction of that sum by markets. While setting up of the NARCL (National Asset Reconstruction Company) will help lighten bad loans, whether this will bump up the valuations of PSBs remains to be seen.

The other point which needs deliberation is whether private promoters have the wherewithal to handle banks with balance-sheet size upwards of a trillion rupees. Take the case of Bank of Maharashtra. With a ₹1.31-lakh crore loan book (and ₹2.02-lakh crore of deposits), it is reckoned as among the smaller but cleaner PSBs and is often rumoured as a privatisation candidate. Its total business in FY22 was ₹3.3-lakh crore.

Private banks such as IDFC First, Federal Bank, Bandhan Bank and RBL Bank lag Bank of Maharashtra by a reasonable margin on business size. Smaller ones such as City Union Bank or Karnataka Bank, viewed as relatively well managed, come nowhere close.

Till date, barring ICICI Bank and HDFC Bank there aren’t many successful examples to showcase that private banks can maintain quality, while attaining the sheer scale of PSBs. In fact, there are more instances to demonstrate that every attempt made by private banks to grow ahead of the system has boomeranged on them — RBL Bank and YES Bank being the recent instances.

Ironically, in both cases, the RBI had to turn to people from PSBs for damage control as they are perceived to be adept in handling stress and can do what it takes to rebuild a large-sized book.

It is gathered that one of the demands of the Fairfax group which has shown interest in IDBI Bank is that LIC (the bank’s current promoter) should remain invested for a few years post the government’s stake sale.

The idea seems to be that bancassurance tie-ups between IDBI Bank and LIC would remain intact as long as LIC continues invested. If there are any loan losses to absorb, Fairfax won’t be bearing the burden alone. This suggests that even with privatisation of PSBs, it would help from the standpoint of capital adequacy and depositor confidence, if the government retains a 26 per cent stake (a critical threshold for voting on decisions) rather than entirely handing over the baton to the incoming investor.

Fit and proper?

The third larger unknown is whether aspirants who seek to take over PSBs will get the regulator’s blessing. Barring PSBs, the RBI hasn’t been comfortable with private promoter groups owning more than a 26 per cent stake in any bank. The first major exception it made was with CSB Bank and Fairfax in 2018.

In case of privatisation that hands over a bank to a single investor (or promoter), the risk to the system can be significant, from the RBI’s perspective.

Passing the RBI’s ‘fit and proper’ scrutiny will be a mammoth task for any private investor.

Having a consortium of investors may be more acceptable to the RBI from a risk management perspective. But that may not cut ice with the investors because ownership and control would be fragmented and, ultimately, rewards may not match the risks taken.

In sum, while bank privatisation may be a laudable objective, putting through PSB sales in the real world is a complex affair. PSBs draw much of their strength, particularly on deposits, from government patronage. For the sake of stability in the banking system and the economy at large, it is imperative to ensure that public trust in banking remains intact.

Therefore, privatisation cannot be viewed merely as a process of replacing the promoters of PSBs. While the Bill is intended at offering sweeteners to incoming investors, the government must be mindful of the operational complexities. Otherwise, the process may end up to be a bitter experience.