View: After 50 years of nationalisation, banking sector calls for crucial changes beyond modifying ownership
Reforms are more important than change of ownership for banks as fintech cos emerge as competitors.
India is the world’s fifth largest economy in nominal GDP. Its largest bank by assets, State Bank of India, ranks 55th by total assets. And no Indian bank figures in the list of globally systemically important banks.
In other words, Indian banking is stunted in relation to the country’s position in the world economy. Blame this, to a certain extent, on that signal event on July 19, 1969 — one day before Neil Armstrong took his giant leap for mankind on the moon — when Prime Minister Indira Gandhi nationalised the biggest 14 private banks of the country. However, the principal blame for the stunting of the financial sector must be placed on the late blooming of the Indian economy and bad politics, besides conservative regulation of finance.
India is one of the places where the earliest records of organised lending can be found, along with Sumeria and Assyria.
Rinam kritvaapi ghritam pibet (drink ghee even if you have to borrow), the materialist philosopher Charvaka is supposed to have said, at least in the caricatured versions of his thought that survive.
Medieval merchants used hundis, the equivalent of a banker’s cheque. The merchant on whom the hundi was drawn would honour the request for payment to the bearer of the instrument. A story goes that a king ran out of money to pay his soldiers while laying siege to an enemy fortress, but had with him a hundi drawn on a rich merchant of the town under attack and sent word that he wanted the hundi encashed, in response to which the ruler of the besieged town felt obliged to let the trader honour the hundi.
The story might be apocryphal, but it goes to show the respect Indians used to have for honouring credit relations in Medieval times — a far cry from the situation these days, when, of the total advances by scheduled commercial banks, as large a proportion as 14.33% by value are classified as non-performing, the ratio going up to 18.77% for public sector banks, according to the Reserve Bank of India’s Financial Stability Report released in June, providing data for March 2019.
Is this the fault of nationalisation? Well, the ratio of gross non-performing assets to total advances was 6.34% for private banks and 3.42% for foreign banks. Clearly, there is something about public ownership that makes banks vulnerable to accumulating bad loans. What could it be?
Since the mid-nineties, when the influx of foreign institutional investors started pouring discerning capital into the Indian stock markets and relatively well-run companies started getting rewarded with huge rise in their share price, leading to an increase in their market capitalisation and the respective promoters’ net worth, listed companies have had a strong incentive to stop concealing their income and earnings. But this did not mean that corporate governance turned from mud to potable water overnight. Promoters still take out huge sums of money from their companies — to fund Indian democracy, besides to build their own personal fortunes. Banks play a big role in the process.
Unlike in developed democracies, the bulk of India’s political funding is opaque. Parties take tribute from promoters, and declare a tiny share of their actual income and expenditure to the Election Commission.
Promoters have to create the stash from which to pay off politicians, inspectors and other officials who have to clear files or refrain from raising objections that are in their power to raise.
Promoters do it when they procure things for their companies, when the company acquires another company — the seller overcharges and passes on the extra to the promoter of the acquiring company in an offshore account — and, most commonly, when the company sets up a new facility.
The project cost is inflated, to begin with. The bank manager and his political bosses are propitiated to make them overlook the cost padding.
During the implementation of the project, the padded cost is taken out and transferred to the promoters’ own kitty, from where he pays out yet more to keep Indian democracy going, apart from to put up the capital for fresh projects for which he would again raise loans.
Cleaning up political funding is a necessary part of cleaning up state-owned banking. Developing a well-functioning debt market to fund long-gestation infrastructure projects that banks, with their short lending horizons, are ill equipped to finance is another step that has to be taken. Another vital reform is creating a remuneration structure for public sector bankers that is in line with their private sector counterparts’. Ideally, it would backload the bulk of pay, linking remuneration to the performance of the assets they originate, subject to claw-back.
Such reforms are more important than any change of ownership, as banks face potential challenge from fintech companies that can compete with them in every one of the assorted services banks perform while mediating savings to investment.