PSU banks. The time to privatise PSU banks is now

The RBI’s recently released ‘Report on Trends and Progress of Banking in India’ (RTPB) and the ‘Financial Stability Report’ (FSR) provide good-quality information and analyses on the state of the banking system in India.

There is no denying that the pandemic has left deep scars on India’s banking system, and it is highly possible that the imperatives of the pandemic-induced ‘new normal’ will impact and influence the risk-return landscape for most economic and business activities in the years to come. Yet, these two publications afford an opportunity to take a close look at the continuum of performance and the challenges faced by the banks in India.

Credit risk in the loan book

The loan portfolios of banks are repositories of 80 per cent or more of their overall risks, reckoned by the regulatory capital required for this purpose. Credit risk exposure-related losses have overwhelmed, especially the public sector banks (PSBs) from time to time, the latest being in the years following the commencement of ‘Asset Quality Review’ in 2014.

Despite this backdrop, a perception has long been created, and particularly in the wake of the Global Financial Crisis (2008-10) that the so-called brick-and-mortar banking involving deposit-mobilisation and loan-making is inherently safe and less risky and any financial innovation such as securitisation and use of derivatives for risk-taking is necessarily bad and unsafe, at best, and reckless speculation, at worst.

There has been a slow revival in the credit offtake of banks in 2021, the latest print being a 7.1 per cent y-o-y rise, most of which has been led by the retail side of their business. The pace of growth of retail credit still remains below its pre-Covid level, though.

In fact, the retail-led credit growth model, which has been adopted as a matter of strategy by most large banks in India, is now facing headwinds. As revealed in the FSR, delinquencies in the consumer finance portfolio have risen, and the new-to-credit segment, a key driver of consumer credit growth in the pre-pandemic period, is showing a decline in originations.

On the wholesale side, while lending to the public sector entities is showing a decent rise, growth in credit to non-PSU non-financial entities witnessed a decline overall continuously for almost two years now, with a modest positive growth for AA and above-rated corporates.

As for the reasons for lacklustre credit growth, the RBI’s research, as revealed in the RTPB, confirms what is already known intuitively: slowdown in industrial activity and investment constrained credit demand, while stressed balance sheets of banks limited credit supply.

A quintessential question that needs to be raised and answered in the context of banks’ role as the principal intermediary between the economy’s savers and borrowers, is whether the credit risks of different types are properly assessed by them using the latest tools and whether the corresponding remunerations are adequate. Unfortunately, the answers to both these questions are not unambiguously in the affirmative.

The FSR provides us with some interesting clues to start pondering on these issues: During the period March 2019 -September 2021, the ratio of the number of rating upgrades to rating downgrades of a select group of non-PSU non-financial corporates fell from 0.66 to 0.35, with a low of 0.06 reached in June 2020.

In general, the portfolio of such corporate borrowers has a propensity of more rating downgrades than upgrades, implying deterioration in the credit risk profile of the portfolio with the passage of time. This appears to be the experience with wholesale credit for a long time.

Do the banks get paid for adverse credit risk migration propensities? No. There are reasons to believe that risk-adjusted return earned on corporate credit has been dismally low for a long time. This is particularly true of PSBs, whose current stressed segment of the wholesale credit at 12.5 per cent is way higher than private banks (PVBs) and foreign banks (FBs).

What adds to the worry is that the feature of adverse credit risk migration is now visible in the consumer credit portfolios of banks. It is not clear at the first sight if this is a consequence of the pandemic-related economic adversity or there is something more durable at work.

Compared to when the pandemic appeared in March 2020, the financial performance of PSBs, PVBs and FBs has now significantly improved. But in the case of PSBs, even a modest shifting of the reference point to 2015 or beyond would tell a very different story: they, as a group continue to be the laggards.

Most significantly, the RoA (return on assets) of PSBs (see table) is not only much less than those of PVBs and FBs, but is a little over half of what was achieved, on average, during the five-year period to 2012-13, the last financial year for which disaggregated business and performance data on banks were published by the RBI.

Similar is the case for all other metrics. An important underlying fact in respect of RoE (return on equity) of PSBs is that they as a group are significantly more leveraged than PVBs and FBs, making them structurally more risky. On the business expansion front, they have fallen way behind: their (y-o-y) CASA growth in September 2021 was 11.6 per cent compared to 22.8 per cent for PVBs and 17.2 per cent for FBs.

Further, the operating expenses of PSBs as a proportion of their total income have risen sharply from 18 per cent during the five-year to 2012-13 to 24.4 per cent currently, whereas this metric for both PVBs and FBs has remained more or less unchanged. These developments bode ill for the ability of PSBs to compete on loan price, all else being equal.

Inadequate political capital

The country needs bold policy initiatives to privatise most PSBs within a time-frame. The rationale for doing so is simple and straightforward: a capital-starved country like ours can ill-afford systematic inefficient use of financial savings and of taxpayers’ money that the government uses to recapitalise PSBs.

A first step toward clearing the political fog surrounding privatisation would be to debunk the myths that have been diligently nurtured over the years to justify the below par performance of PSBs. One such myth has been that PSBs hold the savings of the common people in trust and, hence, their privatisation would be violative of the social contract that underlie the current arrangement.

Fortunately, the Supreme Court, in a recent order, has declined to accept the trusteeship concept. But the popular perception doggedly refuses to accept the debtor-creditor relationship that exists between a bank and its depositors. Also, the message one gets from the last-moment dithering by the government on the introduction of a Bill on privatisation of two PSBs in the just-concluded winter session of Parliament is that political capital required for this purpose is currently in short supply.

The writer is a former central banker and consultant to the IMF. (Through The Billion Press)

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