Does Bank Ownership Matter?

The title of this column is actually a very fertile andactive area of research in the economics and finance academic professions. Thequestion refers not just to ownership by the government vis-a-vis the privatesector, but also between private, domestic and foreign owners. Do banks performdifferently depending on who is the owner? For instance, one research paper onEast and Central European banks suggests that domestic private banks don’t doas well as multinational banks, especially during crisis periods. Another paperon Kenyan banks suggests that government owned banks do much worse than privateowned banks. But one of the biggest banking sectors is in China, where there isvirtually total dominance of State- owned banks. Research on China shows thatgovernment banks tend to be better capitalised, and in times of crisis injectcapital, rather than shrink the assets and recall loans, as found in privateand foreign banks in China. In India too there has been extensive research onthe issue of ownership and how it affects bank performance.

Intuitively one may think that since public sector banks(PSB’s) have the sword of the three C’s hanging on their heads, i.e. CVC, CAGand CBI (or courts), they are inherently conservative in their approach. Thereis no punishment or penalty for not doing anything, or not taking a decision.But if a loan goes bad for genuine or non-genuine reasons, much after the bankofficer has retired, he or she can be hauled up by the investigating agenciesand courts. Besides if indeed the bank officer does very well, the bonus andcompensation policies in PSB’s don’t allow special rewards, as is done inprivate banks. Indeed, there is no reward by way of stock options too, which iscommon in private and foreign banks. The stark difference in salaries of thechief executives of India’s two largest banks, State Bank of India (SBI) whichis and by far the largest, and ICICI which is private, is well known. PSBofficials have also been traditionally suspected to be under pressure fromgovernment authorities to be lenient to give loans to cronies. A recentWhatsApp quip goes like this: “Behind every “successful” businessman is aPublic Sector Bank”! The word “successful” is in quotes, because it is a tonguein cheek comment on some recent high-profile businessmen who have decamped fromthe country, leaving large non-performing assets in PSB’s. So, it follows thatthe performance of PSB’s is inferior to private sector banks, includingforeign.

   

But not surprisingly the research papers on India’s bankingare inconclusive about the impact of public versus private ownership. Indeed,there are metrics which show that PSB’s have done better than their privatesector counterparts, something which many hard-line economists may findsurprising. We should also acknowledge that despite the somewhat pessimisticviews about incentives and governance in PSB’s one should and need not ignore thestellar record over several decades. India’s industrialisation has been largelybank-funded, and financed mostly by domestic savings, not foreign investors.Indeed, India’s average national savings rate during 1950-65 was barely 11% ofthe GDP which tripled, and the average savings rate was 33% during 200-08. Itpeaked at 37 percent in 2008. Similarly, the household sector savings rate wentfrom 7 to 24 percent over this period. Industrial investment rate went up from12 percent of the GDP to a peak of 38 percent in 2008. The mop up of nationalsavings across the length and breadth of the country was made possible due tothe extensive network of PSB’s, not private, and certainly not foreign banks.The latter confine their presence mostly to metro cities. In fact, the twolargest private banks in India are also de facto foreign owned, although theirnetwork is also quite extensive like the PSB’s.

The tremendous growth in mopping up savings, and credit andinvestment ratios of course happened post bank nationalisation. This month wenote that it was fifty years ago that 14 banks were nationalised ratherabruptly. On Saturday 19 July, at 830 pm in the evening Prime Minister IndiraGandhi gave a speech on radio to the nation, announcing this decision. That speech,and the cabinet note and the draft bill (initially an ordinance) was preparedby Special Secretary to Finance Ministry, and eminent economist I. G. Patel. Hewas actually close to Morarji Desai, who had resigned just a few days ago. ThePM’s speech was exactly as IG Patel wrote it, and for once with no interventionor correction from P N Haksar, the legendary secretary to the PM and consideredby many to be her tutor and “alter ego”. It is an irony of history that I GPatel, who was otherwise considered to be market friendly and pro privatesector had to draft one of the most impactful decisions of the Prime Ministerin 1969.

This column will not dwell too much on whether banknationalisation has served India well or not. The evidence is overwhelming onthe positive side. In 2008, when Lehman crashed in the U.S., many largebusinesses moved their cash and deposits wholesale from private banks to PSB’sin India. Even a company like Infosys made a public statement that it wasmoving its cash pile to the State Bank of India. This was at a time when therewas panic, and the public and business believed that PSB’s could not fail.

But just because a decision was taken in 1969, does not meanit has not outlived its purpose. A former FM in Vajpayee government had saidthat the time had come to reduce government stake in PSB’s to 33 percent, butalso retail public sector character. Since the public trusts PSB’s implicitly(rightly or wrongly), it is inconceivable that India will undertake massiveprivatisation of banks. The best course, besides reducing stake, is to give thePSB’s genuine autonomy in their functioning, put in the practice of rewards andincentives, and of course ensure plenty of competition in the banking space.That is the policy direction we seem to be heading toward, and that’s bestunder the circumstances.

(The writer is an economist and Senior Fellow, TakshashilaInstitution)

(The Billion Press)

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