Privatising PSBs

 Privatising Public Sector Banks

As part of her budget speech, Finance Minister Mrs. Nirmala Sitharaman announced in the Parliament that two public sector banks (PSBs) and one public sector general insurer will be privatised during FY 2021-22. Later on when she was interviewed in one of the news channels, she said there was a sentiment around public sector banks that they could not be "touched" but that cannot be the guiding principle for the government. She also remarked that while more public sector banks are welcome, they have to be functionally strong, professionally managed and those that can meet the demands of a growing aspirational India. She also said that the country needs efficient banks for the economy to take the next step and return to the growth path, and cannot have laggards.

While the decision to privatise banks, which were nationalised in 1969 and 1979, is the prerogative of the Parliament, FM did not appear to have taken the contributions of the PSBs in helping the government to build the nation as a whole. In this regard, I also came across a 'whatsapp' forward message, which says that the market cap of HDFC Bank (Rs.5.99 lac cr.) is much more than the combined market capitalisation of PSBs (Rs.5.07 lac cr.) as on 4th January 2021. 

Sometime back, there was another message also doing the rounds comparing the market cap of private sector banks (PvBs) with that of PSBs, where only State Bank of India(SBI) appear to be anywhere near to the major PvBs in market capitalisation. 

Attempting a comparison between the market caps of PSBs with that of PvBs is akin to comparing 'apples' with 'oranges'. All the actions of PvBs are owner (shareholders) centric, whereas the actions of the PSBs are nation centric. While maximising profits and thereby improve Return on Equity(RoE)  and Return on Assets (RoA) drive the business and growth plans of PvBs, achieving optimum profit along  with (sometimes only next to) the necessity to be in the forefront to achieve the national objectives of the government, determines the business and growth plans of PSBs. Lending in areas identified as national priority should be treated as 'investments for nation building' as the returns are long term. For example, the lending in infrastructure projects and opening of branches/ATMs in unbanked areas. In such cases, profit becomes a casualty in the initial years.

    1. Are PSBs laggards?

Hon'ble Finance Minister remarked that the economy cannot have laggards. English Dictionary defines a laggard as one who is sluggish and makes slow progress. Is this true of PSBs? Please consider the following facts:

    a. Nationalisation of Banks in 1969 and 1979 (28 banks were nationalised), enabled the masses in the interior rural and semi-urban space to have bank accounts as well as enjoy credit facilities. Instead of lending to a few big corporates (in order to keep the latter's RoE and RoA intact), PSBs lent in a big way to priority sector comprising small business, SRTOs(small road transport operators), agriculture and allied activities with concentration on weaker sector financing within these different segments. Till a new set of economic reforms were set in 1991, branch expansion was the order of the day and more than 70% of the branches in rural and semi urban areas, which are in existence today, were opened prior to the 1990s.

 

    b. As part of reforms initiated, based on Narasimhan Committee recommendations, banking, insurance and mutual funds(MF) were opened to the private sector. To facilitate their success, consumer lending, which was considered untouchable and treated as unproductive by the regulator till such time, was relaxed in  a big way. More over, the banks were permitted to offer insurance and mutual funds of third parties through their counters. The private players, who entered the banking scene, were clear from the beginning to have retail and the allied activities like credit cards, insurance, MF as their core area. The success of HDFC, HDFC Bank and ICICI Bank from the beginning can be traced to their aggressive marketing of retail-personal, secured MSME and sale of third party insurance/MF products.

    c. While the PvBs had their goals linked to maximising the interests of their shareholders, PSBs were given twin responsibilities - (i) continue to meet the objectives of the successive governments of different parties and (ii) also remain viable to comply with the Basel norms arising out of banking reforms implemented. 

    d. PSBs contributed substantially in financial inclusion and development inclusivity (infrastrcture), the main objectives of successive governments since 2000.

        (i) Infrastructure: Lending to infra, which stood at Rs.7243 cr.  in 1999-2000 increased to Rs.786045 cr. in 2012-13. (a compounded annual growth rate of 43.4%over a period of 13 years) and bulk of the lending was undertaken by PSBs. Credit for the growth of infrastructure facilities with particular reference to power, roads, ports rightfully belong to PSBs. Incidentally the share of HDFC Bank, which has the highest market capitalisation among SCBs in India, is negligible in building the infrastructure requirements of a growing Indian economy. Even today, Power and Roads, the two sectors that account for the maximum spend in infrastructure, continue to get their support only from PSBs.

            (ii) Agriculture: Bulk of the lending to Agriculture and allied activities comes from PSBs and RRBs, sponsored by PSBs. The much acclaimed Green Revolution and more than adequate buffer in food supply became a reality, due to timely scale of finance (include not only cost of production but consumption needs as well) extended by the PSBs year after year till now. FCI could procure the crops at MSP , when the farmers off load their produce, with daily credit disbursals from a list of banks,  (majority of them PSBs), through a well organised credit disbursal programme by a consortium of banks based on their share in gross bank credit (government  subsidy from budget allocations/borrowings from small savings schemes to repay comes later).  PvBs, thanks to the advent of PSLC(priority sector lending certificate), achieve their priority sector targets under Agriculture, by purchase of PSLCs in the market for short periods

         (iii) MSME: As per report on trend and progress of banking in India 2019-20 released by RBI, 60% of MSME lending comes from PSBs (Rs.8.93 lac cr.) with the average ticket size of loan Rs.8.12 lac. (Average ticket size of PvBs  is reported at Rs.2.39 lacs)

    (iv) MUDRA LOANS: PSBs including RRBs lead the pack in the PMMY loans (Mudra loans) launched in 2015. (Total sanctions by all the banks in the last five years is staggering at Rs.14.43 lac cr. extended to 27.70 cr. beneficiaries) under the scheme  

   (iv) Banking in Rural and Semi Urban Areas: As on 31st March 2020, PSBs have 29201 branches in rural areas as against 6160 branches of PvBs. Similarly PSBs have opened 27451 and 39551 ATMs respectively in rural and semi urban areas. PvBs, which account for more ATMs than PSBs in metros (30160 versus 29339) are far behind with the numbers reading at 6046 and 17708 in the respective centres. 

    (v) Financial Inclusion: The number of accounts opened under PMJDY in the last five years crossed Rs.41 cr. recently. PSBs accounted for 33 cr. accounts and RRBs, part of PSBs, stands second with 7.2 cr. accounts. PvBs' share in the whole exercise is a mere 3% at just over 1 cr. accounts.

    (vii) Demonetisation exercise could not have been completed smoothly, but for the wholehearted involvement of the staff of PSBs. Apart from accepting the demonetised notes, all efforts were made by PSBs to enable the public to withdraw cash from the branch counters as well as off-site ATMs. PvBs closed their off site ATMs in most places and the cash disbursals from their on-site ATMs was restricted to their customers.

(I am not making a mention about the way the PSB staff served the society during the COVID lockdown period and the credit facilities extended under ECLGS, since the hon'ble FM acknowledged the services in more than adequate measure in her speeches)

The above points are made not as a defence to cover up the poor RoE and RoA reported by PSBs, but only to point out that a considerable amount of time and money is spent by the officials in these banks to implement the policies framed by the government, to achieve inclusive growth in the society.

         2. Is the financials of PSBs that bad?

As per the Report on the Trend and Progress of Banking 2019-20 released by RBI, the performance of PSBs and PvBs under certain financial ratios, which indicate operational efficiency, are as under:

For the Year ended 31st March 2020 

	Cost of Deposits	Cost of Borrowings	Cost of Funds
PSBs	4.96	4.56	4.92
PvBs	5.26	6.17	5.41
ASCBs (all banks)	5.00	5.36	5.04

 

	Yield on Advances	Yield on Investments	Yield on Funds
PSBs	8.16	6.92	7.76
PvBs	10.10	6.59	9.17
ASCBs (all banks)	8.94	6.81	8.28

 

	Tier I	Tier II	CRAR
PSBs	10.4	2.5	12.9
PvBs	14.7	1.9	16.5
ASCBs (all banks)	12.6	2.1	14.7

                                        

Contrary to public perception, it is interesting to note that in the matter of cost of resources, (whether as deposits or borrowings or overall) PSBs have fared much better than PvBs. Surprisingly, their yield on investments (PSBs are considered conservative in investing in govt securities mainly) is 33 bps higher than PvBs. 

PvBs have scored better in the yield on advances and are also way ahead of their counterparts in CRAR. Reasons are not far to seek as to how PvBs fared better than PSBs in these two areas 

CRAR: Prior to Asset Quality Review (AQR) conducted by RBI, capital infusion was never attempted in a big way by the government, while PvBs brought in capital constantly to address both growth (proactive) and impairment (reaction as a remedial measure).  Capitalising the PSBs was taken up seriously only in the last five years (Rs.3.16 lac crs. have been pumped in by the government) mainly to address the provisions arising out of impairments. In the budget proposal for next FY also, when RBI has projected a jump of 600 bps (7.5% in Sept 2020 to 13.5% in Sep 2021), Rs.20,000 cr. is only provided for capital infusion into PSBs for FY 2021-22.

Yield on Advances (YoA): Two factors contribute to YoA. The share of high yielding advances in the credit portfolio and amount of NPAs, (which sits on the denominator along with other advances, but do not add a single rupee to the numerator, when the yield ratio is calculated). While share of high yielding advances depends on the risk appetite of the individual banks, the same logic do not apply to GNPAs.  As on 31st March 2020, the GNPAs of PSBs stood at Rs.6,78,317 cr.(10.3%) versus Rs.2,09,568 cr.  (5.5%) in PvBs. GNPA is the single most cause for the decline in YoA, reduced interest income on advances, increased provision requirements and decline in net profit. For the P'SBs to match the PvBs, tackling impairment in advances assumes a lot of importance. 

There are no two opinions that the identification, appraisal, sanction, disbursement and follow up standards of PSBs are far from satisfying.  At the same time, there are crucial external factors, some of which are exclusive to PSBs, have also contributed in equal measure to the increase in GNPAs

Regulator's forbearance: CDR, 5/25, S-4 were some of the restructuring schemes introduced for restructuring large advances post global crisis 2008. They were taken as indications to postpone eventualities through 'evergreening' of advances upto 2015-16.The percentage of restructured  large advances was much higher than GNPAs in the period upto FY 2015.

Slow Recovery leading to more write-offs every year: As per RBI report on trend and progress of banking in India 2019-20, on an average, suits filed by the banks with different legal forums (excluding gold loans auctioned in bank branches) is in excess of Rs.7.3 lac cr. in the last two financial years, against which the recovered amount is  in the range of Rs.1.1-Rs.1.5 lac cr. (less than 15%). The maximum recovery came from actions initiated under SARFAESI and IBC. Recovery in respect of suits filed with DRT and Lok Adalats (which account for 30% of the total suit filed amount)  is less than 5%.  The average recovery period in respect of IBC, which was less than 270 days initially is now more than 400  days.

 

MSMEs account for 14.1% of Gross NPAs of PSBs.  Forbearance was permitted since 2018-19 (permitting banks to keep the accounts as standard while restructuring) in respect of MSMEs. One only hopes that the 'ever greening' of advances witnessed in 2010-2015 period is not repeated.

Agriculture: Roughly 15% of Gross Advances of PSBs come from Agriculture with agricultural cash credit (ACC)/ Kisan Credit Cards (KCC) being the anchor.  The GNPAs in this segment is growing unabated, irrespective of the fortunes of monsoon every year.  (As on 31st March 2020, agriculture accounts for 17.3% of the total GNPAs of PSBs). Loan waiver, which culture started in 1986, continues in almost all the states and is chiefly responsible for the decline in repayment culture in rural areas. In order to circumvent the state fiscal deficit, Telengana State  introduced crediting the loan waived amount over a period of four years and the other state government followed suit. As the entire loan was not wiped off in one go, the farmers got an amount equivalent to 25% of the outstanding every year, not enough for cultivating new crops.  So the money was used for consumption needs more often than not , necessitating demand for another loan waiver in the fifth year. Central Government, which introduced credit of Rs.6000 into farmers' accounts directly, could have credited the amount in the KCC/ACC instead of in SB accounts. DBT and aadhaar linkage issues could have been addressed in discussions with the bankers.  This would have ensured that the farmers are in contact with the lenders and renewal of ACC/KCC is more orderly.

Education Loans upto Rs.7.5 lacs Political interference leads to increase in NPAs. The NPAs reported under this segment by PSBs is huge under this category as the loans are unsecured/carry only the personal guarantee. PvBs do not extend unsecured educational loans. Eventually suits had to be filed with the courts/lokadalats/DRTs and even to get a decree, the average time spent is more than 5 years. The political interference continues in recovery also. For example, when a PSB sold its education loan NPA portfolio to an asset reconstruction company(ARC), the ARC started recovery measures. A resolution was passed in the state assembly concerned against the PSB for having sold its NPA portfolio to an ARC for recovery purposes. 

 

        3. Is privatisation the panacea to all the ills? 

Right from the former governor and deputy governor, every one advocates that PSBs will turnaround much more efficiently, if they are privatised. One do not get the confidence, if the history is any indicator. 

1. Global Trust Bank, failed in its first attempt to merge with UTI Bank, was merged with Oriental Bank of Commerce, an efficient PSB at that time, in 2000

2. Times Bank, a new generation private bank after reforms, was merged with HDFC Bank in 2000.

3. Yes Bank had to be rescued by investment into equity by select banks, with SBI leading the pack with an investment of 49%

4. PMC Bank was placed under moratorium 

5. Shadow Banks or NBFCs to be precise IL&FS and DHFL were taken to NCLT by the government/regulator for resolution.

Failure in all the above banks/NBFCs are due to reasons of corporate governance related issues, exposing the depositors/creditors to grieve, if remedial measures were not in place immediately.

In addition, there were serious corporate governance issues in the second largest PvB, ICICI Bank involving alleged conflict of interest in sanction of loans to a big corporate.

        4. Whether intended move guarantee success:

Trade Unions, Employees in PSBs, Communist Parties and a section of the General Public have already opposed the move. How the government will respond and what will be the final outcome to the current proposal to privatise two PSBs is anybody's guess.  I felt that instead of privatising two PSBs, the government could have diluted its share holdings to less than 75%, a mandatory requirement from SEBI which should have been complied with long ago. The government holds more than 80% equity in 9 out of 12 PSBs (SBI, BOB and Canara Bank are the exceptions). Instead of infusing equity through preferred allotments, had the banks  went in for rights issue in the past, it would have helped in increasing investor confidence.

There are three categories among the 12 PSBs to-day. 

    i. State Bank of India (SBI), 

    ii. Merged PSBs - 5 - PNB, BoB, Canara Bank, Union Bank of India, Indian Bank

    iii. Unmerged PSBs - 6 - Bank of India (BoI), Bank of Maharashtra, Central Bank of India, Indian Overseas Bank(IOB), Punjab & Sind Bank and UCO Bank

SBI is nation's pride, firing from all cylinders, whether in fulfilling government objectives of inclusion and inclusivity or in financial performance. So it is automatically excluded from the list of banks to be privatised. What the government wants to achieve through privatisation will have a bearing in the selection of two banks in the remaining eleven. 

If the aim is to get a maximum amount from disinvestment, then it should select the stronger ones

If the aim is save the exchequer from infusing capital repeatedly, it should go for the weaker ones.

If the aim is to convey to the market that the government is open to more privatisation in the future, it may select one each from the strong and weak bank category.

In my opinion, the Finance Ministry might opt for stronger ones so as to drive market sentiments as well as to derive maximum out of disinvestment.

But there are several issues to be addressed before finalising:

1. Picking up a PSB, which is a merged entity of 2/3 PSBs, will give rise to a lot of HR problems apart from issues relating to  IT and rationalisation of branches/admin offices. It takes a minimum of three years for human resources to reconcile to work along and for streamlining the different systems and procedures into one.

2. IOB, CBI, UCO Bank are still under PCA. Even if they come out in the near future, they would have complied with only two parameters out of the three triggers resulting in PCA viz.  NNPA ratio less than 6% and CRAR above regulatory prescriptions. Even if they show a positive RoA as on date, there is uncertainty due to COVID related stress in assets  and standstill in classification of NPAs from 1st August 2020. The reported RoA is also marginal compared to what the market has set as benchmark rates. 

3. BoM and Punjab & Sind are regional oriented and BOI is a bank with international presence. Emotional issues are possible.

4. PE, Price to Book Value, RoE, RoA are arithmetical ratios and need not necessarily convey the inherent value of the PSBs, which comes from the net work of branches/ATMs/BCs, experienced staff  and decades old loyal customers. The same issues that were raised, when LVB was taken over by DBS Bank might come into the fore again.

5. IDBI Bank though named as PvB due to government's disinvestment taken over by LIC, government holds a stake of more than 45% and the PSU insurer holding 51%. The investments are yet to be passed onto the private sector in the real sense.

6. PNB and IDBI Bank raised equity from the market recently through QIB recently.  The subscription was only upto 50%, subscribed mainly by the PSUs.  If this is an indicator of market's confidence on PSBs, disinvestment might not be easy.

7. Regulatory restrictions may have to be removed to allow major PvBs to evince interest in organic mergers.

8. Non-Resident FIs are the major share holders (more than 40%) in ICICI Bank, HDFC and HDFC Bank, IndusInd Bank and Kotak Mahindra Bank.  The same story might repeat in respect of this exercise also.  In that scenario, there is no guarantee that national objectives will take a precedence over RoE, RoA, PE, PB ratios which drives the markets in attracting investments.

 

 

V. Viswanathan 

20th February 2021