As chief economic advisor Arvind Subramanian says, the case for privatising state-owned lenders has probably never been stronger. The government should use the fraud at Punjab National Bank, as also the large defaults by a host of other promoters, to explain to the public that banks need to be privatised because capitalising them without making other changes is simply throwing several lakhs of crores of good money after bad. While the banking system in India has faced crises in the past, this is a time of crisis and as Subramanian points out, this is an opportunity to improve public policy. There is no doubt that the efforts initiated by the Reserve Bank of India to clean up banks’ balance sheets, and the infusion of capital by government—all taxpayer money—will come to nought unless accompanied by reform that ensures the twin balance sheet problem doesn’t resurface in a few years. That is probably true—unless there is a material ownership change at these banks, the money could once again be frittered away. Subramanian argues that while recapitalisation, to some extent, creates a moral hazard, in reality nothing comes free, so policy makers need to balance the ‘perverse incentives’ created against the need to revive the economy and create jobs.
Privatisation of government banks should result in less political interference and put an end to the crony capitalism, which really is the root of the problem. However, the government can continue to dictate to lenders they must do some amount of directed lending—to agriculture, the priority sector and so on—as priority sector norms apply to all banks, not just public sector ones. But internal controls are likely to be far better in a private sector bank. More critically decision–making can be much faster and will not suffer from excessive caution as it often does in a state-run bank where top executives are fearful of an investigation by the CVC/CBI and the CAG. In fact, had state-run banks been able to take decisions without fearing action by the investigative agencies, exits in India may have been more frequent; banks would have taken a hit and moved on rather than resorting to ever-greening.
As Subramanian puts it, exit is especially difficult when public sector banks lend to private sector firms; once the bad lending occurs, getting out is difficult for fear of being seen as favouring certain groups—typically the promoters and others. While it is not as though private sector banks run smoothly without any problems—there have banking crises in the West with the best of lenders getting into trouble—Subramanian argues that private participation makes regulation more effective. The reason is that public ownership creates complicated three-way lines of control, ownership and regulation between government, the regulator and the banks themselves. However, there is less of this three-way complication when the private sector is involved.
Indeed, the continuous infusions of capital will be wasted unless the PSU banks find new owners or are altogether disbanded with the assets and liabilities being taken over by other lenders. Given the general elections are a year away, the government will find it hard to ‘sell’ the banks since no buyer will taken on the bloated workforces in this age of digital banking. But the government can use the PNB fraud to mobilise public opinion and convince them it is their hard-earned money that is being looted by ruthless promoters.