Bank privatization will be a futile exercise to begin with

Instead of trying to privatize public sector banks, government and RBI need to improve their efficiency and credibility

During the presentation of the budget in 2021, Finance Minister Nirmala Sitharaman announced that the government had budgeted Rs 1.75 lakh crore from the sale of stakes in public sector enterprises and financial institutions. This included two public sector banks. Earlier, the Niti Aayog had recommended the privatization of three such banks – Bank of Maharashtra, Indian Overseas Bank and Punjab

and Bank of Sindh.

In July 2021, Finance Secretary TV Somanathan said: “We have now announced that public sector banks, most of them, will eventually be privatised. To say that they are finally privatized and that they are actually privatized are two different things, but we are actively trying to privatize them. And banking is one of those sectors where ultimately only the bare minimum of public sector banks will remain, this is the stated policy. Around one million bank workers went on strike in December 2021 to oppose the government’s decision to privatize banks. Leaving aside the merit or not of privatization, here an attempt is made to analyze just to reveal to what extent the possibility of privatization of banks exists today.

Firstly, amendment of the Banking Companies Acquisition and Transfer Acts of 1970 and 1980 and the Banking Regulation Act of 1949 is required to proceed with any privatization of banks. This may be possible because the ruling party has a comfortable majority in parliament.

There are “on-demand licensing standards for banks” published by the Reserve Bank of India. Although these standards are applicable to any new banking license, they should be interpreted as also applying to any new entrant wishing to buy a bank, as the RBI cannot relax any

such standards.

Any sale of state banks can be based on its valuation. One way to know the valuation is based on its current market capitalization, as these banks are publicly traded. According to data from the National Stock Exchange, the market capitalization of these banks stands at Rs 724,436.21 crore (31 March 2022). These banks are not wholly owned by the government. The value of government stake in these banks (based on market capitalization) stands at Rs 480,207.35 crore. It may therefore be important to find buyers who have at least this financial capacity. In the event of a successful privatization, market capitalization may also increase depending on investor perception.

Large industrial houses, whose income from non-banking sources exceeds 40% of the total, will not be eligible to set up a bank in the country under the RBI’s banking license standards. This means that industrial houses like Reliance, Adani, Tatas and Birlas cannot have a banking license and therefore cannot participate in the government’s bank privatization program. Only individuals with 10 years of experience, as well as business groups with Rs 5,000 crore in total assets will be eligible for a banking license provided that the non-financial activity of the group does not account for 40% or more in terms of total assets. /in terms of gross income.

There don’t seem to be any individuals (without an industry connection) with the net worth to take over a government bank.

Existing private banks may be eligible to take over public banks, provided they are willing to bid for it. But here there are two constraints. Firstly, private banks may not be interested in buying public banks, given the working culture and the huge number of staff. It will be a long process to change the work culture in an organization with decades of experience. Getting rid of excess staff will also be difficult.

Second, private banks do not have enough excess funds to take over banks. These are required to have a cash reserve ratio of 4.5% and a statutory liquidity ratio of 18%. Thus, a bank can comfortably lend only 78% of its deposits. If a bank lends more than that, it is borrowing, not depositing. We call it the credit-to-deposit ratio. Now see the credit-to-deposit ratios of some major private banks (see table). It can be seen that invariably all of these banks have a CD ratio of over 78% and therefore they borrow to meet their credit demand. The financial situation of these banks will not allow them to buy public banks.

Another type of entity eligible to buy public banks can be non-banking financial companies (NBFCs). They may meet fit and proper criteria. However, an NBFC that is part of a group where the non-financial activities of the group represent 40% or more in terms of total assets/gross income is not eligible to become a bank.

Major NBFCs such as Bajaj Finance Limited, Shriram Transport Finance Company Limited, Aditya Birla Capital Limited, L&T Finance Holdings Limited, Cholamandalam Investment and Finance Company Limited and Sundaram Finance can all be part of the industry group and not get the banking license.

(The author is a retired banker. Opinions expressed are personal.)

Shawanda H. Saldana