Public sector banks: To be or Not to be

Preface

Financial sector is like the skeleton, it gives the support and structure to a nation's economy. We have public-owned banks, private entities, and co-operative institutions that comprise our financial sector. A bank pays you interest on your deposited money through earning a greater amount of interest on a loan that it has lent. If a bank doesn't get back the money that it has lent to someone, it becomes a Non-Performing Asset. If the number of NPA rises to a certain extent that the bank runs out of its running and reserve capital, it goes bankrupt. To keep them afloat the government keeps infusing money in case of public sector bank or in case it's a private bank some formula is worked out to bail it out. This things have become quite common in case of public sector banks as the following section will show. Government in order to fix this temporarily did mergers which made the balance sheet look good for sometime, but eventually one way or the other the balance sheets showed the mirror.

Let's talk data

Market capitalization of a company is a good measure to evaluate how a company is faring. If you look at the market capitalization of top private banks it is almost more than twice that of the public counterparts. According to a RBI report 85% of the NPAs are with the public sector banks. Though public sector banks relatively lend more and hence the majority of the NPAs can be attributed to them. So let us look at a more nuanced data point which is NPAs Vs Gross Advances(which is loans lent by a bank). According to a paper published in 2020 in Global Journal of Finance and Management, the average NPAs of public sector banks stood at 5.14% of their gross advances while for private counterparts it was pegged at 1.28%.

The above graph comprehensively summarizes how there is a steep increase in the gross NPAs of state owned banks while for private and foreign banks it has more or less remained constant. Though this graph only included data till 2018 and there was indeed a steep decline in NPAs of public banks in 2020, but whether it was because of number jugglery pulled off by mergers of different public banks or policy measures, remains to be seen. It can be hence clearly stated that at least data suggests that private banks are faring better than the public ones and public banks might be draining out the economy as they are not being able to manage the NPAs and hence affecting the credit flow.

The Counter

Economics is perhaps the only science which has people divided on the basis of ideology. We have people with likes of Raghuram Rajan and Viral Acharya who advocate a cautious and a selective privatization spree of banks. While people on the left of them term this idea as outright disastrous. The foremost argument against this is that many private banks have also failed in the past. Superficially, it sounds logical but it is just stating the most basic fact of how a bank runs and making it suit their narrative. Banks be it private or public are not risk averse and they are bound to go out of business if they are not competent enough. The second argument is that private banks will only serve the rich and the poor will be left to fend for itself. I think the solution to this is just incentivizing the banks and have certain provisions in place to ensure no one is left behind.

Another popular argument that pops us frequently is that private banks have promoters which are behind a curtain and hence they should not be trusted for example as happened in case of the Yes Bank. But you cannot cherry pick a case and then paint everyone with the same brush. Also, every absconding defaulter has taken the loan from a public sector bank, which the private players declined to lend because it seemed too risky, which eventually turned out to be true. So the public sector banks in a way are more prone to getting bankrupt and are not trust worthy equally, if not more than private banks.

Conclusion

The proposed privatization as of now only talks of two banks. And to answer the question of "to be or not to be" lies somewhere in the middle. The government will be present in the financial sector for strategic purposes and it will need to strike a balance between letting the private players play and restricting itself to a certain part of the field, so as to ensure the financial sector remains healthy. The sceptics do have valid points but they apply basically to anyone. As of now what data indicates is definitely that disinvesting this stressed assets is better, rather than having to temporarily fix it by just doing a rewriting of numbers in the books. It seems "Running loss is the rule. Making a profit is an exception."

Image credits: Global journal of finance and management.