The structure of the industry is changing. Going forward, fee-based wholesale and retail activities and complex financial products are likely to be far more important to banks. Here is where banks need superior human capital to excel. Government salary norms and administrative rules hamstring PSBs vis-à-vis their competitors.
PSBs are also losing the more affluent and younger customers to their private sector and foreign competitors. These trends are well captured in the considerably lower valuation multiples of PSBs compared with private banks. With listing and partial privatization, PSBs are increasingly being evaluated on profitability and competitiveness without the operational freedom that others enjoy.
It is only fair to let the PSBs play by the same rules if they are expected to deliver similar results.
But what about the social responsibilities of PSBs? Will this not be a banking sector solely targeted for the urban rich? Will banks any longer open branches in remote rural areas to aid financial inclusion? Will the government and RBI be able to achieve their distributional policies through banks?
The massive expansion of PSBs into rural areas was largely a feature of the 1970s and 1980s when licences were issued for urban or metro branches only if a certain number of rural or semi-urban branches were opened by the bank—the 4:1 rule. The pattern for branch expansion changed dramatically in the 1990s. With liberalization, PSBs effectively stopped adding rural branches. Given the same incentives, PSBs are no more inclined to serve the inclusion agenda than their private competitors.
From the government’s perspective then, inclusion is better served by setting appropriate norms and providing incentives at the policy level, without distinguishing between public and private banks. Both are equally likely to promote inclusion if and only if they find it in their best interests to do so.
Similarly for directed credit. In recent years, private banks have actually directed a greater share of their lending to priority sectors than PSBs though the composition of priority lending may be different.
Historically, bank nationalization has led to more credit to agriculture, villages and public sector undertakings but not to the small scale sector or thrust areas identified in recent five-year plans.
In terms of the credit quality of priority sector lending, PSBs have fared relatively poorly.
Uniform and detailed priority sector lending norms are likely to yield similar lending patterns on the ground regardless of whether the lender is a private or a public bank. Allowing banks to trade priority sector lending credit would ensure that priority sector lending is allocated to banks according to their capabilities in this area.
The core principles guiding these recommendations include regulations based on function, rather than form; and the separation between policymaking and bank management.
Policymakers should set suitable incentives and allow independent banks to pursue efficiency in that setting, not meddle in their functioning through action-specific regulations. Therein lies the essence of second generation reforms in Indian banking.