Why privatising poorly run banks is a must

The non-performing assets (NPAs, jargon for bad loans) of state-owned banks are approaching five per cent of total advances; their private sector counterparts have NPAs that are between one-tenth and one-fifth of that level.

The critical task facing Indian banking is to quickly improve the risk-assessment capability of the state-owned banks, which account for three-quarters of all banking; and if that fails, then to privatise them.

This task is being ignored in favour of a non-solution, the starting of new private banks.

These won’t go into operation for the next two years, and will not have any sizeable impact on the economy for a good decade, ie until they achieve scale.

At that stage, if they are successful, the country will be faced in all likelihood with the prospect that confronts it in other sectors (like telecom and aviation) where state-owned companies have been left to their own devices while new private sector players have been allowed in.

The taxpayer is asked to endlessly cough up money to keep the state-owned telecom and airline companies going; indeed, he is already being asked to do so in the case of state-owned banks.

The bill will climb as the public sector banking segment gets slowly pushed into a corner. But the obvious solution of privatisation is a political no-no, especially for the Congress; the country is therefore being treated to a long-term option that, if it works, will create a bigger long-term problem.

Meanwhile, a Reserve Bank deputy governor on short-term extension has been persuaded to finalise guidelines for the issue of new private sector bank licences that match the preferences of the finance ministry.

According to news reports, he will be rewarded for playing ball with a full year’s extension. All manner of economists and experts have warned against the dangers of allowing large business houses to also run their own banks.

Their opinions have been ignored.

The RBI governor held off until he was given additional powers of supervision.

Various regulatory provisions are supposed to prevent banks from financing their parent business houses—but nothing can prevent a bank from extending credit to suppliers of those business houses, who in turn can give extended suppliers’ credit to the houses in question.

In short, there is no foolproof way of putting Chinese walls in place, as the fond hope seems to be.

Given the prevailing level of corporate governance standards as well as of crony capitalism, what is now proposed carries with it an element of risk that was entirely unnecessary. But the die is cast.

If four or five banking licences are to be given, and if the applicants include the usual Tata-Birla-Ambani as well as Bajaj-Mahindra-Murugappa, and in addition if there are applications from Life Insurance Corporation or its subsidiary, L&T Finance, IDFC and sundry others like Religare and Indiabulls, the choice is going to be a hard one. The key test will be whether the consideration of who is “fit and proper” to run a bank is done well or badly. Watch out for who is given the task.

(Disclosure: Kotak Mahindra and associates are significant shareholders in Business Standard Limited)