Indian banks in crying need for reforms; here’s how privatising PSU banks can help

PSU banks have been busy fighting one emergency after another, be it demonetisation or mergers.

Even as the Indian banking industry remains stable amid a severe economic downturn, there is a crying need for reforms in the industry. The downward risk arising from the vulnerability of Scheduled Commercial Banks (SCBs), mostly the PSU banks, is worrisome, and needs to be addressed immediately, said a report by Brickwork Ratings. The balance sheets of banks were already under severe stress before the pandemic hit. On top of that, the crisis created by the pandemic and moratorium offered is expected to deepen the hole in the banks’ pockets. In the latest RBI’s Financial Stability Report, the Gross NPAs of banks are projected to swell from 8.5 per cent in March 2020 to 12.5 per cent under a baseline scenario, and up to 14.7 per cent under a severe stress scenario by March 2021.  

The projections for PSU banks are more pessimistic as the GNPAs may shoot from 11.3 per cent in March 2020 to 15.2 per cent under a baseline scenario and to 16.3 per cent under very severe stress scenario by March 2021. In fact, the ratio of a bank’s capital to its risk, also known as Capital Adequacy Ratio (CAR), is estimated to deteriorate from 14.6 per cent in March 2020 to 13.3 per cent under a baseline scenario and to 11.8 per cent under a very severe stress scenario by March 2021. 

Privatisation of PSU banks

The RBI has proposed to cut the government’s stake in six PSU banks to 51 per cent over the next 12 to 18 months. The reform could initiate measures to improve the governance structure of these state-owned banks and bring in much needed additional revenue, said the Brickwork ratings. Privatising the ownership of the banks will change the structure of incentives and accountability, lends the banks to more effective supervision and regulation, and subject them to market discipline, it added.

The public sector banks have been busy fighting one emergency after another, be it demonetisation or mergers and they do not have any incentive to take risks and perform better as the government pumps in taxpayers’ money from time to time for recapitalisation, it further said. 

Meanwhile, both – domestic and global – factors are perceived to pose high risks. While the global risks arise from a protectionist tendency, security concerns, and supply chain disruptions, the domestic factors arise from the unprecedented economic crisis created by the coronavirus pandemic. The intensity and duration of the pandemic remain unknown, and the discovery of the vaccine is still a work in progress. Heightened risks arise from a contraction in the GDP, high fiscal imbalances due to lower revenues, higher health expenditures are among major threats, the report added.