Every crisis generates its own side business. The current one is the clamour for privatisation of public sector banks.

The Punjab National Bank episode opened new wounds regarding the performance and prospects of PSBs. The issue of high level of NPAs with PSBs and their often getting into a spot thanks to scams and scandals raise concerns that need to be addressed seriously. The solution, however, is not privatisation.

The huge amount of lucre awaiting the privatisation process that offers rich pickings for investment banking, buying strategic stakes, and legal and advisory, valuation and intermediary services, provides enough ground for this high-pitched advocacy. But, looking at the evidence from emerging markets and the imperatives of public policy, the whole argument falls flat.

First-hand experience

Firstly, India’s experience is not encouraging. When, in 1991, the Narasimham Committee (on financial sector reforms) heralded the opening up of banking to the private sector, analysts had almost written off PSBs. What eventually emerged was something different.

Of the ten private sector banks given licences in the new economic regime, three (Times Bank, Centurion Bank, Bank of Punjab) merged with other banks. Since no private sector bank was big enough in 2004 to take over Global Trust Bank, it was ultimately amalgamated with a PSB, the Oriental Bank of Commerce (OBC). Another, IDBI Bank was converted into a PSB. The argument that 20 PSBs is a large number runs contrary to the existence of 21 private sector banks, many of which are still on the fringes of Indian finance even all these years.

Not so impressive is the international experience. In September 1982, Mexico was forced to nationalise 58 of its 60 private banks. In 1991, it privatised many banks but had to rescue them once again in 1997 (post the Tequila Crisis of 1994-95) at a fiscal cost of nearly $65 billion.

A long stretch of sour episodes requiring huge rescue packages from respective governments — in some cases the rescue packages exceeded 40 per cent of GDP — continued thereafter with crises in South-East Asia (1997), Brazil and Russia (1998), and several other countries.

A decade later, in 2008, it was the turn of pedigree private commercial and investment banks in developed markets that were on the verge of going belly up to be saved with public money. The number of banks that either failed, were distressed or were merged — all of which are private — since 2009 runs into several pages on the website of the US Federal Deposit and Insurance Corporation.

The picture in China

In quite sharp contrast, China was able to reach the top of the global banking scene riding on state-owned banks. The Industrial & Commercial Bank of China, the China Construction Bank, the Agricultural Bank of China and the Bank of China top the global league table of banks with an asset base of $12 trillion. These four banks raised a phenomenal $70 billion in new capital in global stock markets.

It is not just China and India, but much of the BRICS community that too have a significant contingent of state-owned financial institutions.

It is also important to note that much of the problem in global banking did not come from state-owned banks.

In the developed markets, the share of state-owned banks in assets is less than 10 per cent of the banking system and in the developed economies it is just about double that. In the emerging markets, the share of state banks in assets declined from 67 per cent in 1970 to a little over 20 per cent now. These banks, however, are very critical for credit stabilisation in time of a crisis.

For instance, BNDES (Brazilian Development Bank) of Brazil and other government-owned banks in Mexico, Korea, Poland and some other countries were commended for their counter-cyclical role in ensuring credit flow when the crisis gripped the financial world. India is no exception.

It is said that 95 per cent of countries experienced a contraction in bank credit for at least one month between September 2008 and May 2009. ‘Phoenix Miracles’, a scenario in which recovery in real output happens without recovery in credit flows, remains rare and sporadic in developing markets.

The instances of PSBs turning out to be good tools to fight financial crises with, are many.

It’s not that public sector banks in India were always in a precarious situation. In the first of a comprehensive review of PSBs held in 1993, many were found to have been saddled with huge NPAs. With reasonable levels of fiscal support, opening them up to competition, evaluating them on efficiency parameters and providing access to public capital markets, India was able to revive and resurrect public sector banks.

In a short period of time, they emerged as favourites of the stock markets with highly liquid indexes (BankNifty/Bankex) in India’s bourses.

Look for the right mix

Once again, it is possible to put PSBs back in focus with the right mix of policy and reform.

The robustness and vibrancy of the economy determines the health of domestic finance rather than issues of ownership. There are murmurs about some of the so-called savvy new private sector banks concealing bad debts till the central bank pulled them up.

The World Bank in its maiden Global Financial Development Report (2013) which was devoted to the the role of state in banking, aptly sums up two building blocks for successful domestic finance: “First, there are sound economic reasons for the state to play an active role in financial systems. Second, there are practical reasons to be wary of the state playing too active a role in financial systems. The tensions inherent in these two building blocks emphasize the complexity of financial policies.”

The priority now surely is to strengthen the first building block while reforming the second one.

The writer was chief economist of Indian Banks’ Association. The views are personal

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