Privatisation of Banks: A Brief Overview

Privatisation of Banks: A Brief Overview

The government has decided to make a few amendments in the Banking Laws (Amendment) Bill, 2021 which aims to privatise two public sector banks. The banks which the NITI Aayog recommends to privatise are supposed to bring in 1.75 lakh crore worth of capital in the government exchequer. This drive of privatisation of banks will reduce the government’s stake from the present 51% to 26%. The government is thinking to bring the Bill in the winter session and for the privatisation of the two public sector banks necessary amendments have to be made in the Banking Companies (Acquisition and Transfer of Undertakings) Acts of 1970 and 1980 and Banking Regulation Bill, 1949.

Nationalisation of Banks in 1969

The government of India in the year of 1969 initiated the process of nationalisation of commercial banks. This was done keeping in view the financial position of the country that the country was undergoing and the country had serious and genuine requirements for investing the nation’s capital in prioritised sectors such as agricultural development, establishment of heavy industries. Investments were also needed in other sectors such as big businesses, small businesses, export sector etc.

In the year of 1969, the decision of nationalisation of commercial banks was necessary because of the then financial position of the country where there was lack of disposable capital to be invested in the priority sectors. However, the present needs for privatisation of public banks are different. In today’s time, the need of the government is to build strong banks with higher lending capacity and have loss absorbing capacity to cover losses in the form of NPAs. The government believes that introduction of the private sector will bring along the benefits of increased efficiency in the operations and opportunity to adopt innovations in the banking sector which the government is unwilling to undertake.

What is meant by ‘Privatisation’?

Privatisation is a process whereby the government ceases to keep control over the ownership and management in the government owned company and transfers the same to a privately owned company. Such a step is taken by the government thinking that privatisation will bring in more efficiency and turn the debt ridden loss making government entity into a profit making one.

The first time privatisation was done was after the historic budget of 1991 which introduced for the first time the policy of liberalisation, privatisation and globalisation.

What is ‘strategic disinvestment’?

Strategic disinvestment is a process of selling the stake of public sector undertaking to a private entity by liquidating its assets and transferring the control in the management to the private sector. Generally, the control is given upto 50 percent of the undertaking or such percentage as the competent authority allows.

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The need for strategic disinvestment arises when the government wants to be relieved from the fiscal burden of the undertaking or with a view to raise capital for investment for certain specific purpose.

Legislative framework for privatisation of banks

The recently introduced bill of Banking Laws (Amendment) Bill, 2021 aims to introduce necessary amendments in the existing Banking Regulation Act, 1949 so that privatisation of two banks can be initiated which the government proposed in the Union Budget of 2021.

The government wants to make amendments in the Banking Companies (Acquisition and Transfer of Undertakings) Acts of 1970 and 1980 to give effect to the said privatisation drive.

Another statutory law that plays a big role in the proposed privatisation of the bank is the Banking Regulation Act, 1949[1] which is responsible for regulating the firms involved in the banking business. It also enables and empowers RBI to regulate the control moratorium, mergers of banks and their liquidation. 

Need for Privatisation of Banks

Now the question that arises is the need for privatisation of public banks. Though the process of privatisation of Banks is a complicated and tedious process, yet the government wishes to go ahead with such an idea because of the following reasons:

Rising Non Performing Assets (NPAs) by the Banks

One of the most important reasons, among many others, which actually triggered the government to go ahead with the privatisation of the banks is the rising number of NPAs followed by decreased profitability, market capitalisation and poor performance record. In order to unburden itself from these stressed assets, the government wishes to liquidate its holding in the company thinking that entry of private sector will introduce efficiency and improvement in the bank.

Recommendations from several committees

The government had established a number of committees with the objective of bringing reforms in the banking sector. Some of the committees that have been set up by the government have made recommendations to bring down the stake of the government in the public banks below 51 per cent.

  • The Narsimhan Committee recommended 33 per cent stake of government in the public sector banks.
  • The PJ Nayak Committee recommended government stake below 50 per cent.
  • Recently an internal working group of RBI has recommended conversion of some NBFC’s into banks.

Increase in Lending capacity and Formation of Big Banks

The government’s objective is to form big banks by merging the public sector banks with the existing private banks so that these banks develop in size and scale and proportionately increase their lending capacity. This will consequently increase the risk taking capacity of these banks.

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The banks with bigger lending capacity can invest more in the high valued developmental projects and undertake investment in projects of national importance.

Vision for Future of banks

The privatisation of banks matches with the long term vision of the government to have limited number of public sector banks and rest of the banks get either privatised or get merged with the existing private banks. This will decrease the burden of the government wherein government has to infuse liquidity in these banks to cover their losses.

Creation of Strong banks

Another purpose of privatisation was to create strong banks and reduce the strength of public banks thorough privatisation and merging them with the other private banks. A strong bank with deep pockets has better chances in absorbing NPAs and in managing risks. The chances of a strong bank going bankrupt are reduced and a few failed projects will not affect the bank’s existence because of the sheer size of the bank.  

Concerns related to Privatisation of Banks

Following are some of the concerns related to the privatisation of banks:

  1. Concerns of crony capitalism with the privatisation of banks: When these public banks will be privatised, they will be sold off to the private players which are already defaulting in repayment of loans. This will actually worsen the situation and increase the number of NPAs by these banks.
  2. Financial exclusion of the weaker sections of the society: An important function of the Public sector banks is to bring the fruits of banking services within the reach of last person of the society. Privatisation of these banks means that these banks will only be concerned with the rich and affluent sections of the society and ignore the less affluent ones.
  3. Job fear amongst the existing employees of the public banks: When the public banks will be privatised or merged with the other private banks, the banks will avoid duplication of workforce and start downsizing their employee strength. The news of merger creates panic in the workforce regarding the uncertainty about their future position in the newly merged bank. The uncertainties can be regarding job profiles, position in the bank, promotions, salaries, changes in perks, downsizing of extra workforce etc. Though these concerns may look seemingly small, however experiences in the private sector are evidence to the fact that an unsatisfied and worried workforce has the potential to bring down the entire company.
  4. Unregulated activities: Lately, a number of big loan default cases and NPAs have come to the fore. This reflects the inability of the RBI to curb this menace when the public sector banks were under the direct control of the RBI. However, when these banks will be distanced from the RBI’s control, there are certainly higher chances of default.     
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The reasons for the introduction of privatisation of the Public Sector banks is to bring in the necessary improvements in the governance and management of the public banks and also to unburden the government from the losses incurred by these banks due to rising NPAs. A need is also felt to devise a statutory framework that treats a wilful defaulter of bank loans as a criminal offender. Many recommendations have been made by the committees appointed by the government to systematically reduce the amount of government ownership and management control in the public sector banks and extend the same to private sector so that efficiency of the banks can be increased. However, it must be remembered that blind privatisation of banks is fraught with concerns like crony capitalism, loss of jobs, financial exclusion of weaker sections of the society etc. Instead, the government should turn them into corporations which can give the necessary autonomy to the banks in their operations without having the government to lose ownership control in the banks.

Digital Banking and Neobanking: the way forward to Privatisation of Banks

Another banking revolution that is waiting to take over the traditional banking system is the development of Digital Banks and Neobanks. The neobanks are those banks that deliver the banking services to their customers without the need to maintain physical branches using superior technology and artificial intelligence.

Neobanks are nothing but financial institutions that are able to leverage the use of technology in providing quick and cheaper banking services to their customers with negligible maintenance costs.

As of now, the RBI prioritises physical banks over neobanks because it wants physical presence of some of the representatives of banks. The RBI does not grant license of banking to these banks. Neobanks are only operational through their partners to whom they have licensed out their services. With the rapidly changing banking needs of the tech savvy generation, sooner or later the transition will take place and traditional banks will be forced to adopt these changes in their system.

Read our article:Neo Banks in India: Will it be the new normal?

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