Don’t Allow Public Sector Banks To Wither Away, Says YV Reddy

The government must decide on the share of banking that should be retained in the public sector, says YV Reddy.

Dr. Y. V. Reddy, former governor of the Reserve Bank of India. (Photographer: Namas Bhojani/Bloomberg News)
Dr. Y. V. Reddy, former governor of the Reserve Bank of India. (Photographer: Namas Bhojani/Bloomberg News)

“Banks were nationalised at the whim of a Prime Minister, they will be de-nationalised at the whim of another Prime Minister.

With those words, Yaga Venugopal Reddy, former governor of the Reserve Bank of India, sets the tone for a conversation on the past, present and future of India’s government-owned banks. It has now been 50 years since Indira Gandhi, then prime minister of India, took a decision to nationalise 14 private banks. The decision, Reddy says, gave the central government powers that were never envisaged in the constitution.

“Suddenly you found that the Union Government had access to public deposits, access to huge financial resources, not contemplated in the constitution. Second, they got huge financial resources outside parliamentary control. Third, they got access to huge administrative machinery in different states, which was not contemplated in the constitution,” Reddy explains.

These powers continue to be a big lure for politicians, who may have debated and discussed privatisation of government-owned banks but have stayed far away from giving up control of these lenders.

Even today, public sector banks command 66 percent of credit and 65.7 percent of deposits. This network continues to be used by each successive government to push both political and economic objectives.

“You see all sorts of schemes, Pradhan Mantri this, that and the other...all these use the banking machinery,” Reddy points out. Schemes such as the Pradhan Mantri Jan Dhan Yojana and the Pradhan Mantri Mudra Yojana, implemented through PSU banks to increase penetration of bank deposits and low-value credit, reinforce Reddy’s view.

Some would argue that this developmental role played via public sector banks justifies their existence. Reddy, however, believes that nationalisation of banks was more justifiable in 1969 than it is today.

There was greater justification of nationalisation at that point of time than for continuation of public sector banks now. Relatively.
YV Reddy, Former Governor, RBI

Reddy explains that the record of private sector banks, at that time, was poor. The capacity of the private sector was also undeveloped, which justified the need for a “good” public sector, Reddy says.

Since then, the availability of good private sector has increased and the availability of a “good public sector” is in doubt. “Therefore, there is a case for a review...but this is complicated by political economy considerations.”

Don’t Allow Public Sector Banks To Wither Away, Says YV Reddy
50 Years Of Bank Nationalisation: The Banks That Were

One Big Joint Family

Reddy, in a speech in 2017, referred to the government, the public sector banks, and the RBI as a joint family or a “Hindu Undivided Family”, where no one kept proper accounts of what they were doing with each other or the rest of the economy. “The belief was that they were all serving people.”

Reddy explains that the RBI was not really a regulator in those days. All priorities were set by a central plan, which banks and the RBI implemented. In 1980, when the government announced a second round of nationalisation, the message was clear, says Reddy. “They selected three private sector banks, which were doing well.... The signal was that if you grow, you will be nationalised.”

With no private sector to speak of, there was little for the RBI to regulate.

Soon after nationalisation, they created a position of institutional finance. We had continuous meeting with banks. We discussed where the bank branches should be put, to whom the loans should be given. If the loans weren’t recovered, banks bear the cost. But the government gives subsidy. But you never know. There was no allocation or transparent accounting of who did what, at what cost and for what benefit. That is why I called it a joint account, like Hindu Undivided Family.
YV Reddy, Former Governor, RBI
Conference of in-charges of the Department Of Banking Operations and Development, 19 February, 1981. Image Courtesy: RBI History Volume 3
Conference of in-charges of the Department Of Banking Operations and Development, 19 February, 1981. Image Courtesy: RBI History Volume 3
Bank Nationalisation: The Original Sin?

The Forgotten Promise

By the early 1990s, it was clear that the Indian financial sector needed reform. Two committees set up under M. Narasimham in 1991 and 1998 were tasked with laying down a road map to prepare the Indian financial sector for a liberalised economy.

The 1998 committee dealt directly with reform of government-owned banks and recommended both governance reforms and a reduction in the government’s ownership in these lenders.

In 2001, then Finance Minister Yashwant Sinha proposed to reduce the government’s minimum shareholding in PSU banks to 33 percent. Eighteen years later, that proposal has seen no progress.

Everyone has forgotten about it. So, there is virtually consensus among the political leadership of the country that they would like to retain the political hold over the banking system. At least, I presume that’s what it is.
YV Reddy, Former Governor, RBI

Share Of ‘Non Captive’ Business

While there may have been no privatisation of government-owned banks, there has been privatisation of banking. Private banks and non-banks have gained a larger share of incremental business, particularly over the last few years when public sector banks have been burdened with bad loans.

To assess the true share of public sector banks, Reddy believes that the share of ‘non captive’ business should be looked at. He explains this by saying that a lot of business from the government and government agencies goes directly to public sector banks.

“Government business will be with government banks. I will call it captive market and non-captive market. In the non-captive market, private sector banks are expanding rapidly. Non-banking is filing the area which banking should do,” Reddy says, adding that privatisation of banking is happening organically.

Should the economy then just allow public sector banks to wilt away?

Reddy does not believe so. Even today, the average citizen of India is most comfortable banking with PSU banks, he says. As such, Reddy still sees a role for public sector banks and believes they should have a strategic presence.

“What does strategic presence mean? You decide that so much percentage (of banking) should be in public sector. Determine through competition which public sector banks should be supported. Public sector banks which are doing well, you support. Those public sector banks which are not doing well, sell away the shares. Then there will be competition among them.”

Reddy believes, by rough estimates, that about 30 percent share of banking should remain in government control to ensure needs of the economy are met.

He, however, wonders whether the banks, which remain in the public sector, should be 100 percent government owned.

Reddy explains that at times, such as when the government recapitalises PSU banks, private shareholders benefit by not having to share the burden of recapitalisation. In contrast, private shareholders lose out because they have little say in the functioning of government banks in which they may be shareholders.

What advantage has there been of having partial private sector ownership? Has anyone evaluated? It is possible that 100 percent public sector banks will be better?
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Image Courtesy: RBI History Volume 3
Image Courtesy: RBI History Volume 3

Inefficiencies: Of PSU Banks Alone? Or Public Sector As A Whole?

Reddy, who served as banking secretary and has been on the boards of State Bank of India, ICICI and IDBI, has seen the functioning of government-owned banks up close.

He believes that corporatisation of public sector banks is an important first step in improving their functioning. This would allow for discretion in government shareholding, greater accountability of operations and increased flexibility in personnel policies. Parity should also be ensured in anti-corruption and vigilance-related provisions between public and private sector banks ⁠— a long standing demand of PSU bankers.

Reddy, however, does not think that the creation of a ‘Bank Investment Company’, which creates a layer between the government and the banks, will help. “If government wants to give autonomy, it can give. It does not need an intermediary to give autonomy.” Mergers, another often cited ‘reform’ for public sector banks, is no solution either, according to Reddy. “If there is a common problem of governance, merger does not solve the problem of governance.”

Reddy also argues that the often-cited inefficiencies of public sector banks should not be seen in isolation. These may reflect inefficiencies of the public sector as a whole, he says. “So, part of the banking problem is political and part of the problem of public sector banks is a reflection of inefficiency of public sector systems in the country as a whole,” Reddy says, citing shortcomings of public health and education systems.

In final analysis ⁠— a phrase you’ll often hear Reddy use ⁠— India still needs its public sector banks but in a thought out and purposeful way, he says.

Don’t allow public sector banks to wither away. We require public sector banks but focused, purposeful, limited and competitive public sector banks. Enable them to compete but not on same measurement of performance. 
The Day India’s Banks Died

Watch the full interview here

Why Indira Gandhi Nationalised India’s Banks