After the PNB-Nirav Modi scandal, there was an explosion of comments calling for the privatization of public sector banks. It’s much more complicated than that.
“To pride all the woes of India’s banking sector on state-owned banks alone is a gross oversimplification of the problem. “
This is a line from the Congress Party’s economic resolution, presented at its 84th plenary session on March 18. This seemingly innocuous phrase suddenly seems far-sighted now, following the events surrounding India’s largest private sector bank that have unfolded in recent weeks.
In the weeks following the outbreak of the Punjab National Bank-Nirav Modi scam, commentators, pundits and luminaries have erupted in calling for the privatization of public sector banks, implying that government ownership is at stake. the root of all the ills afflicting the Indian banking sector.
These calls suddenly ceased after allegations surfaced around senior management at ICICI Bank, even prompting The Hindu to publish an article titled “Call for Privatization of Public Sector Banks Gets Weak” on April 4. Any diagnosis of India’s bad debt problems as solely a matter of public ownership of the banks is simply lazy. That is why.
In addition to mandatory priority sector loans to sectors such as agriculture, Indian banks choose to lend to two broad categories: consumers and businesses. Data from the Indian banking industry since 2000 shows that, on average, a loan to a business is twice as likely to deteriorate as a loan to a consumer.
In other words, lending to businesses is about twice as risky as lending to consumers. This is understandable since business loans are exposed to inherent business risks, while consumer loans are usually secured by regular income streams and collateral. The more banks lend to companies, the more their non-performing assets (NPA) will be important, that is to say the bad debts. Thus, any prudent bank that wishes to limit its NPAs should lend more to consumers than to businesses.
Over the past two decades, out of Rs 100 loaned by banks, on average, private sector banks have loaned Rs 60 to businesses and Rs 40 to consumers. But public sector banks have loaned Rs 88 to businesses and Rs 12 to consumers. Clearly, public sector banks choose to lend much more to riskier companies, regardless of their size. Simple calculations tell us that public sector banks are likely to experience larger NPAs than private sector banks, simply because they engage in riskier business lending more than consumer lending.
Even within private sector banks, ICICI Bank and Axis Bank lend more to businesses than HDFC Bank or Kotak Bank, in proportion to their loan portfolio. Indeed, ICICI and Axis have higher NPA ratios than HDFC and Kotak. There is a simple linear relationship between the ratio of business loans and bank NPAs. To what extent the seemingly lower NPA ratio of private banks to PSU banks is simply due to the avoidance of risky corporate loans, as opposed to better lending discipline, is still unclear. So before any big statement that PSU bank NPAs are higher just because they are government owned, one needs to adapt to this fact first.
So, shouldn’t PSU banks shy away from lending to riskier businesses and switch to larger consumer loans?
Over the past two decades, PSU banks have granted nearly three-quarters of all Indian business loans. Suppose there was a board diktat in 2005 at the State Bank of India that its ratio of business loans to consumer loans is the same as, say, HDFC Bank. This would have meant half a trillion dollars less in loans for Indian businesses during the decade 2005-2015. bridges, airports, roads and steel mills, and generated the millions of jobs it created during that time?
There are no easy answers to these questions, but the most important point is that the bad debt issue is much more nuanced and complicated than that of simple public sector banks versus private sector banks. It is quite naïve to conclude that privatization is the panacea for India’s bad debt problems.
There is a rich history of banking sector crises caused by crony and reckless lending across the world, but evenly distributed between public and private sector banks. Banking is the simplest form of business of taking someone’s money and giving it to someone else, but it sounds like a complete lack of what mathematician Nassim Taleb calls ” Skin in the game ”, the title of his new book. A quote from a banker in the book sums it up well: “I like to give large, long-term business loans because by the time the loans come due I may be long gone!”
To be sure, India’s public sector banks are not models of efficiency and integrity, and that is no excuse. There can be many reasons for the privatization of Indian PSU banks, but it is certain that a higher NPA ratio cannot be one of them. As the congressional economic resolution says, “it will be a blatant simplification of the woes of India’s banking sector.”
(The author is chairman of the data analysis department of the Congress party.
For detailed data and analysis – https://www.bloombergquint.com/opinion/2016/08/18/the-half-truth-of-prudent-private-sector-bank-lending)
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