Getting The Bank Balance Right

Context: While India warms to the idea of bank privatization, a public bank movement is in vogue in the United States.

Benefits of government presence in the banking sector: A case for public banks

• Overcome market failures: especially in the early stages of economic development.
• Improve welfare:  by allocating scarce capital to socially productive uses.
  • There are reports that public banks can contribute to state revenues, support community banks, fund public infrastructure projects etc.
• Enable efficient government transfers and financial inclusion: through universal checking accounts.
  • E.g.  Pradhan Mantri Jana Dhan Yojna (PMJDY) for transferring payments to ultimate beneficiaries is administered primarily through government-owned banks.

Problems associated with government presence in the banking sector: A case for private banks

• Possible distortion of credit allocation and allocative efficiency: due to commandeering the lending apparatus to achieve political goals. -> lower levels of financial development and growth.
• Low profitability of Public banks compared to private banks: Reasons
  • Low private-credit to Gross Domestic Product (GDP) ratio: In India, where Public sector Banks (PSBs) dominate (60% of the assets), the private-credit to GDP ratio is only 50% (lower than international benchmarks. e.g. In United States, it is 190%).
  • Higher Non-Performing Assets (NPAs) in PSBs: Gross NPA ratio in PSB is 10.3%, while it is only 5.5% in private banks in India. This is due to poor credit allocation by public banks.

Conclusion: Ideally, a banking system should be an optimal mix of public and private banks as public banks are better at performing payment services function while private banks are better at performing lending functions.