From 1947 to 1955, 361 private banks in India had failed, leaving depositors in the lurch. On the midnight of 19 July 1969, 14 of the largest commercial banks in India, which accounted for 85% of all deposits, were nationalized. In the almost five decades since, we’ve managed to stabilize and expand access to banking to the people. India now has more than a billion bank accounts.
The argument for this drastic step was the delivery of credit. The private banks would only lend to a select few large industries and businessmen. In 1967, the lending to agriculture as a percentage of total lending was 2.2%, and shrinking. Through nationalization, the government could direct credit towards the priority sector: agriculture, small industries, traders and entrepreneurs.
But if you have read the news lately, you would think the public sector banks don’t know how to distribute credit. From 2015, the Reserve Bank of India (RBI) has changed the way banks report their non-performing assets (NPAs). This uncovered a mountain of bad debt, triggering the introduction of the new insolvency and bankruptcy code in 2016. The recent announcements by RBI have brought a larger section of loan accounts into the new approach, which focuses on the viability of borrowers.
The central bank has shown uncommon courage in pushing forth to remove the scourge of crony capitalism once and for all. This increases the pressure on PSU banks to provision more losses, and on the government to provide more capital. The Nirav Modi case has only brought more systemic problems under the spotlight.
Most importantly, along with all the challenges of NPAs, systems, human resources and governance, PSU banks now also face a rapidly evolving existential threat.
Technology is a double-edged sword for finance. On the one hand, it has greatly expanded access. Many of the 300 million Jan Dhan accounts opened since 2014 have been enabled by Aadhaar electronic know your customer (eKYC) norms. On the other hand, technology is inverting the banking business model from low-volumes of high-value transactions at high cost to high-volumes of low value transactions at low cost. This is primarily driven by the rapidly plummeting costs of transactions brought on by the India Stack based on the Jan Dhan, Aadhaar, Mobile (JAM) trinity. The dramatic move towards a less-cash economy powered by the Unified Payment Interface (UPI) will further change the competitive dynamics of the banking sector.
The failure of audit controls in the Nirav Modi case or NPAs also demonstrates how not just transactional banking, but even audits need a technological re-imagining.
It is possible to create a digital audit powered by artificial intelligence (AI), which is real-time and preventive instead of post facto and reactive.
But the rapid digitization also means bankers, public or private, have to engage in a cyber arms race they are not trained for against fraudsters and hackers.
The opportunities and threats of rapid technological change thus make it even more difficult for PSU banks to cope. And yet, despite nationalization, India is still credit starved. Our appetite for credit will only grow as GDP does.
Moreover, low transaction costs using digital means it is feasible to serve customers that couldn’t be served before. Credit in the economy will only deepen.
A recent Morgan Stanley report estimated the sector will grow from $370 billion to $1.8 trillion by 2027.
The same report estimates that in 2017, PSU banks will have a market share of less than 10%. PSU banks will be left dealing with their legacy issues, stranded assets and technology challenges, while private banks and non-banking financial companies respond nimbly, capturing most of that deep credit growth.
Given that financial inclusion and lending to the unserved is now possible with technology, the arguments for a State-owned thrust further wither away. The market knows these truths and today, HDFC Bank alone has a market capitalization higher than the top 22 government-owned banks combined. The share of new loans issued by PSBs have dropped from 49% in 2014 to just 28% in 2017.
The argument for privatization, then, is simple. It is already creeping up on us, whether we like it or not. Technological disruption has made it even more critical. By divesting from PSU banks, and yet devising a way to keep the upside of their future growth, the exchequer can still capture the value that is inexorably being eroded from these banks. Privatization is no longer a question of if, but when.
The views expressed here are personal.