A speculative news report states that the government is likely to designate banking as a strategic sector under the new privatisation policy. This will allow the government to own a maximum of four public sector banks (PSBs), and thus, some PSBs which have not been included in the already completed consolidation process will be privatised.

There are right now just a few mega PSBs — SBI which has absorbed all its associate banks, Bank of Baroda which has taken in two other banks and four large banks, which absorbed six others.

The government’s policy on this score has been outlined with great clarity by the principal economic adviser who has said the government is “clear and unapologetic” about privatisation of public sector enterprises as a part of reforms. Given current market conditions, this can take time, but any delay will not be on account of “lack of intent”.

Privatisation as one element of the overall reform policy is fine, but adopting it as the foremost plank in banking sector reform, mainly because right now it is politically easy thing to do, is fraught with adverse consequences. To get a sense of the total picture, it is useful to refer to what Raghuram Rajan had to say over a year ago in the book What the Economy Needs Now , edited by Abhijit Banerjee and others.

Rajan’s overall point is that ‘simple’ solutions like privatising all PSBs may be no panacea. To this, a further point needs to be added: consolidation and privatisation of PSBs can have little to do with setting Indian banking right, as these actions may be necessary, but will not be sufficient by a long chalk.

The best proof that the problems of Indian banking transcend issues of ownership lies in the plight of YES Bank. The cardinal malaise of Indian banking is a lack of adequate governance, stretching across public and private ownership, and it stems from the nature of Indian politics and entrepreneurial culture.

Politicians will not allow PSBs to be run professionally, and promoters of private banks, too, often try to run too fast and cut corners in the process. Plus, there are issues of personal probity, which have come to light over the actions of former leaders of some of the largest private sector banks like ICICI Bank and Axis Bank.

Specific reforms

Underneath this overarching reality, Rajan, with his clear-sightedness and academic rigour, has outlined a range of actions that need to be taken to address issues bedevilling PSBs.

First, The Company Law Tribunal needs to keep evolving, so that it acts as an apex body to which only defaulting companies that cannot be restructured through negotiation can be brought for bankruptcy proceedings. For the negotiation process to work, bankers need to be confident that their commercial decisions will not come under subsequent scrutiny. Plus, the Bankruptcy Code has to be made effective and transparent so that it cannot be gamed by unscrupulous promoters.

Second, the hardy old point is that the governance and management of PSBs has to improve. The way to do this was outlined by the PJ Nayak committee, which recommended distancing between the government and top public sector appointments (everything the Banks Board Bureau was supposed to do but could not).

Third, instead of getting involved in a sterile debate over privatisation, why not follow an evidence-based approach? Why not privatise a couple of mid-sized banks and take government ownership to below 50 per cent in a couple of other banks. This will give us three types of ownership: wholly government-owned, majority government-owned and large minority stake held by the government. Attempts at better governance across these can yield valuable lessons on what works and what does not, irrespective of theory and ideology.

Fourth, overall, de-risk banks which handle too many risks, by letting them handle what they can and transferring the rest to non-banks and the market. Financial market development is integral to this exercise. Interest rate volatility and project risk are elsewhere passed on to the market or non-banks. The latter should access the market for equity and develop a market for subordinate debt. Sometimes, risks which banks seek to avoid return to them. Banks don’t like to lend to property developers so they lend to non-banks who lend to the developers. But when a weak non-bank goes under, the banks are left holding the baby. To reiterate, to de-risk banks, develop a wide and deep financial market which can absorb non-bank equity and have a range of instruments to capture different kinds of risk.

Finally, reduce the number and weight of mandates for PSBs. By now, the well-established one is debt waiver for farmers. They need a lot of help from the government but debt waiver, which eats away at repayment culture, is not one of them. It is equally pernicious to subject banks to mandated lending. Right now, they are being exhorted to lend to MSMEs. They are damned if they don’t and damned if they do (when the loans go sour).

So merely privatising PSBs will get you nowhere. A whole lot of intricate sector-specific reforms must also be carried through to get useful results.

The writer is a senior journalist