Two recent pronouncements, one by the Prime Minister in the Lok Sabha on the role of the private sector and the other by the Finance Minister about lifting the embargo on private sector banks (PvBs) from conducting government business, have left a signalling impact on the ecosystem of private sector initiatives in India.
The RBI, after it was established in 1935, was empowered to carry out the general banking business of the Central and State governments through its own offices and through the offices of the ‘agency banks’ — SBI and later public sector banks (PSBs) — appointed under Section 45 of the RBI Act, 1934, by mutual agreement. And the RBI pays agency commission to agency banks for the government business handled by them.
From October 1, 2003, four PvBs — Axis Bank, HDFC Bank, ICICI Bank and IDBI Bank — were allowed to handle government business in a selective manner. The move was aimed at enhancing the quality of customer service in government business through more competition, improving customer convenience by increasing the number of customer service outlets and broad-basing the revenue collection and payment mechanisms of the government. However, the government imposed an embargo on further expanding the list of PvBs, initially in September 2013 for a period of three years and then subsequently renewed the restrictions in 2015, 2017 and 2018.
Now, the government has lifted the embargo “to ensure a level playing field to all public sector and private sector banks, enhancement of customer convenience, enabling innovation and the latest technology in the banking sector, and spurring of competition for higher efficiency and increase in standards of customer service, ultimately leading to all-round value creation.”
This is a significant development because (a) this further levels the field in favour of PvBs, and (b) this is a prelude to privatising PSBs which may gather speed after two of them are privatised as announced in the Union Budget 2021-22. Furthermore, it will increase competition between PSBs and PvBs, thereby generating operational efficiency in the conduct of government business, and enhancing the penetration of the Direct Benefit Transfer (DBT) plan.
Government business is lucrative for banks as it is a source of bulk deposits, giving them ‘float’ money which can be deployed in the overnight money market, and helps garner low-cost and stable deposits, facilitates customer acquisition, and most importantly, generates commission income.
The deposits kitty
According to RBI data, deposits of the government sector (Central and State governments combined) stood at ₹11,796.40 billion at March-end 2020, which was 1.8 times that at March-end 2010 and 4.5 times that at March-end 2005. This underscores the importance of government deposits from the viewpoint of resource mobilisation by banks.
The commission income
Chart 1 presents the total amount of agency commission earned from the RBI by all the agency banks, and its ratio to their total ‘commission, exchange and brokerage’ income.
The year 2015-16 witnessed a sudden spike due to the increase in government expenditure, including pension arrears and growth in the economy resulting in higher levels of government tax and non-tax receipts, and provisions made for reimbursing service tax on agency commission paid to agency banks.
The ratio reflected a declining trend, steeply so in the post 2015-16 period. This may be attributed to the migration of government transactions to electronic mode, especially after GST was launched in July 2017 and the integration of government systems with RBI’s e-Kuber for direct processing of government payments and receipts.
Furthermore, during the decade, while agency commission showed a compound annual growth rate of 2.9 per cent, commission, exchange and brokerage income (excluding agency commission) for agency banks grew at 8.7 per cent.
The ratio may be small and declining, but in a situation where the interest income of banks is squeezed, every drop of non-interest income via agency commission would count to support the bottom line.
Boon and bane for banks
Thus, liberalisation has come as a boon for PvBs. There are at least two factors that will help them garner government business. For one, they are more aggressive in their marketing and lobbying than PSBs, and technology-savvy. Second, their staff incentive structure is favourable to solicit government business. However, there are some pain points.
First, their branch network is not as wide and deep as that of PSBs. In the case of the government’s schematic allocations, money is utilised through various departments/agencies right from the village or block level. Here, PSBs, (especially the SBI), which have large networks of rural and semi-urban branches, will score over PvBs. Perhaps some of the old and small PvBs, especially those in South, which have penetrated into smaller areas, may have an edge over new PvBs. The PSBs will have a tougher task of holding on to existing government deposits if the government decides to auction temporary surplus whereas in this case PvBs can quote finer rates to garner funds.
Second, PvBs, with their less permeated branch network will find it challenging to dispense small-valued pensions which are manpower-intensive. It will be difficult for PvBs to pinch the existing business of PSBs, as a pensioner would not like to shift her pension account to another bank as it is procedurally cumbersome and inconvenient to operate.
Therefore, to begin with, PvBs should focus on garnering ‘new’ government businesses. This will also help them acquire new customers to whom they can cross-sell non-banking products.
The way forward
Going forward, government business is likely to increase with the rising number of taxpayers, developmental programmes and the DBT. In order to carve out larger segments of the increasing pie, PSBs need to review their government business models and strategies including staff incentive structures.
Nonetheless, levelling the field does also warrant that PvBs should participate equally in the implementation of the government’s developmental programmes as PSBs are doing. In the case of the Pradhan Mantri Jan-Dhan Yojana, out of 420 million beneficiaries, the share of PvBs was just three per cent (March 10, 2021). While lifting the embargo the government has added a caveat that PvBs found wanting “in the achievement of implementation of social sector Government initiatives and Schemes” will be subjected to periodical review and permission “to the concerned bank to undertake Government business could be potentially withdrawn”.
Be that as it may, the latest measure will push Indian banking into creeping privatisation and at the same time improve India’s score in the ease of doing business.
Rath is a former Chief General Manager of the RBI and Das is a former senior economist with SBI. (Through The Billion Press)