Expect Banking Revival in 2021

Context: The resilience of the Indian banking sector during the last year shows that the government should review its plan for sale and privatization of Public Sector Banks (PSBs).

Positive indicators in the Banking Sector:

• DecliningGross Non-Performing Assets (GNPAs) which stood at 8.16 % at the end of September 2020 as opposed to 8.2 % in March 2020.
• Increased Provisioning: Net NPAs were down due to the increase in Provision Coverage Ratio (PCR) of banks from 42 % in 2016 to 72.4 % in September 2020.
• Emerging out of crisis: Kenneth Rogoff and Carmen Reinhart (economists) estimate that it takes a banking sector eight years to emerge from a crisis. ( 2011-2012 as the start of crisis should mean revival in 2022)
• Strong growth prospects: India’s real Gross Domestic Product (GDP) to grow by 10 % in 2021-22 and that may translate into credit growth of over 15 % for banks.
• Improvements in the governance of PSBs: The quality of top appointments has improved under the Banks Board Bureau and improved governance due to consolidation of banks.

Issues with the recapitalization of banks:

• Issue of money down the drain: A common issue is that capital infusion often is inefficient due to the low valuation of PSBs. There are two reasons for it:
  • Risk-averse: Mangers at the PSBs are reluctant to take risks impacting their profitability.
  • Lack of adequate capital infusion: impacts the regulatory minimum, which is supposed to be maintained by the banks in order to increase their valuations.

Issue with privatization: Shedding majority ownership in PSBs at one go could seriously jolt depositor and investor confidence and adversely impact growth in financial savings

Way forward: To deal with problems associated with PSBs

• Empower PSBs to address bad loans through restructuring and a one-time settlement: rather than creating a bad bank.
• Free PSBs from political interference: By amending present laws is enough and there is no compulsion to create a Bank Investment Company (BIC) to hold government shares of PSBs.
• Plan recapitalization and privatization properly: Adopt a three-phased approach.

1. 1. Provide adequate capital to the stronger PSBs and just enough capital to the weaker ones to improve performance and valuations,
   2. Attempt a strategic sale of a few weak PSBs and watch the outcomes for a few years.
   3. If the outcomes are satisfactory, allow the government stakes in other weak PSBs to fall below 51 % and hold on to majority ownership in the stronger PSBs.

Conclusion: Government should not act in haste to deal with the problems of PSBs; rather, it should act with caution.