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RBI paper bats for gradual ceding of government control from banks

On financial inclusion, the article found that public sector banks account for the highest share of bank branches in rural areas, followed by semi-urban areas, in adherence to their commitment to the financial inclusion objective. (MINT)Premium
On financial inclusion, the article found that public sector banks account for the highest share of bank branches in rural areas, followed by semi-urban areas, in adherence to their commitment to the financial inclusion objective. (MINT)

The government has already announced its intention to privatize two banks. Such a gradual approach would ensure that large scale privatization does not create a void in fulfilling important social objectives of financial inclusion and monetary transmission,” the RBI paper said

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MUMBAI : Adopting a “big bang" approach to privatisation of public sector banks would do more harm than good, said an article published by the Reserve Bank of India (RBI) on Thursday, instead batting for a more gradual withdrawal of state control.

The article, written by Snehal S Herwadkar, Sonali Goel and Rishuka Bansal of RBI’s banking research division of the department of economic and policy research was accompanied by the usual disclaimer that views expressed are those of the authors and do not reflect the views of the organization. It was published in RBI’s August bulletin. 

“The government has already announced its intention to privatize two banks. Such a gradual approach would ensure that large scale privatization does not create a void in fulfilling important social objectives of financial inclusion and monetary transmission," the article said.

Finance minister Nirmala Sitharaman had announced in the Union Budget for FY22 that the government will pare stake in two state-owned lenders apart from IDBI Bank, without specifying names. 

In support of its stance, the article said that there is evidence that public sector banks (PSBs) are not entirely guided by the profit maximization goal alone and have integrated financial inclusion goals in their objective function unlike their private peers. Some of the recent reforms in the financial sector, it said, would also lead to strengthening of these banks.

“Our results also point out the counter-cyclical role of public sector bank lending. In the recent years, these banks have also gained greater market confidence. Despite the criticism of weak balance sheets, data suggests that they weathered the covid-19 pandemic shock remarkably well," it said. 

The recent mega merger of 10 state-owned banks, the article said, has resulted in consolidation of the sector, creating stronger and more robust and competitive banks. That apart, the establishment of National Asset Reconstruction Company Ltd (NARCL), India’s bad bank, will help in cleaning up the legacy burden of bad loans from their balance sheets, it said. The article added that the recently-constituted National Bank for Financing Infrastructure and Development (NABFiD) will provide an alternate channel of infrastructure funding, thereby reducing the asset-liability mismatch concerns of public sector lenders. 

“Overall, these reforms are likely to help strengthen the PSBs further," it said.

On financial inclusion, the article found that public sector banks account for the highest share of bank branches in rural areas, followed by semi-urban areas, in adherence to their commitment to the financial inclusion objective. The PSBs dominate in meeting the credit demand of rural areas and while private banks have been making some inroads in the rural areas, their progress remains slow.

“It is often argued that private banks (PVBs) meet their priority sector lending target of 40% fully and thus contribute towards financial inclusion. Granular data, however, show that the PVBs have met their priority sector targets not through organic lending but through investment in priority sector lending certificates (PSLCs), especially in agriculture and small and marginal farmers categories," it said.

Using mathematical models, the authors looked to at efficiency levels of banks in India over between 2010 and 2022. The results suggest that when profit maximization is the sole motive, efficiency of the PVBs has always surpassed that of their public sector counterparts. However, when the objective function is changed to include financial inclusion—like total branches, agricultural advances and priority sector advances— state-owned lenders prove to be more efficient than PVBs, it said. 

That apart, an analysis by the authors also showed that labour cost efficiency

remained higher than PVBs for most of the years except 2016, implying that incurring lower cost on labour, public sector lenders can generate higher level of output.

Discussing the counter-cyclical role of state-owned lenders, the article pointed out that while larger and stronger industries can access the equity market easily, it is scarcely available to smaller entities, making bank funding a preferred alternative. 

 

“This was especially true during the cyclical downturn that started in the Indian economy since 2017-18. By providing credit to industrial sector, the PSBs have played counter-cyclical role," it said, adding that state-owned banks are also more effective in monetary policy transmission, aiding the counter-cyclical monetary policy actions to gain traction. 

During the last easing cycle for example, their reduction in lending rates was substantially higher than that of PVBs and at the same time, their deposit rates were relatively stickier as compared with PVBs, it said.

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