7 main arguments for privatisation of banks in India

Privatisation has become a popular measure for solving the organizational problems of governments by reducing the role of the state and encouraging the growth of the private sector enterprises. However, privatisation takes a number of forms and has been approached in various ways during the move away from government control to other forms of owner­ship in developing countries.

In 1969, on 19th July, an event of great political significance took place when the then Government, headed by Smt. Indira Gandhi, nationalized 14 major Indian banks. On 15th April, 1980, six more Private Banks were nationalized.

Begin­ning 2nd October, 1975, 196 Regional Rural Banks have been established in the country. After 31 years, the Government of India introduced a Bill in the Parliament on 13th Decem­ber, 2000 providing for reduction in Government equity in the Public Sector Banks from existing "not less than 51%" to 33%.

In other words, the 67% of equity would be held by Private Sector and Government equity will be around 33%. This intent was no doubt in continuation of the process of liberalisation of the banking industry that began in the early 1990s.

After the deregulation of interest rates, issuing of licenses to new private banks, liberalizing of branch licensing policy, lending policy, even with recruitment policies of banks, it was natural to progress toward de-nationalization.

Privatisation is a political process and has important economic and social implications that not only affect enterprise performance, but also social welfare and stability.

The social effects have to be considered in any impact assessment, particularly those related to employment, social safety net measures, social privatisation that results from the extension of share ownership to small investors and employees, and the role of public utilities and services in economic and social development.

It is therefore important that the framework for evaluating policy developments, including all forms of privatisation, is clearly set in advance.

In the course of banking liberalisation, Reserve Bank has so far granted licenses to 9 private sector banks up to March 2003. This apart, many foreign banks are allowed to set up branches / offices in India. Simultaneously banks were encouraged to go for mergers as in the case with Times Bank Ltd with HDFC bank and Bank of Madura Ltd with ICICI Bank Ltd.

The new privatisation policy also led to a large-scale reduction in the staff strength PSU banks. We are aware that thousands of bank staff was shown the door under 'VRS' policy. However, the objective of privatisation is to improve the functioning and profitabil­ity of Government owned banks. Let us now discuss the merits and demerits of this policy.

The following may be the arguments for privatisation of banks in India:

I. Public sector ownership has an inherent handicap due to it being extremely dif­fused. This makes it less amenable to effective control by shareholders, compared to private ownership.

2. Bank nationalization had given monopoly to the government in the banking industry. As in case of any monopoly situation, the quality of service went down and the people suffered.

3. State ownership of banks reduces competition and breeds inefficiency.

4. There is no evidence to suggest that State ownership lowers the probability of bank­ing crises.

5. The sale of public equity of banks may be particularly lucrative now. Twelve of the 27 PSBs and 19 private sector banks are listed on stock exchanges, and the market has ap­preciated their recent performance.

During the years 2001-02 and 2002-03, all PSBs declared high profits, with some banks reporting 200 to 300 per cent growth in their bottom-line!

The bullish bond market enabled many banks to book record trading profits in trading in Govt, securities. Additional good cheer was the passage of the new Act, which enables banks to seize the assets of defaulting borrowers.

6. A sixth rationale for privatisation is that it enhances efficiency and productivity through proper management and control.

7. The competition, not merely ownership, is the key. And foreign competitors might bring additional benefits take fresh capital as shown in other emerging markets. A foreign owned bank, with large capitalization, can withstand local disturbances better.

8. The private sector and foreign banks can resist local government pressure to lend to favored sectors.

9. Frequent recapitalization of State-owned banks is a huge burden on the Government budget.

10. The relative insensitivity of the public sector banking system to its cost structure, inability to respond quickly to the changing market trends and the greater rigidities in the management decision-making processes because of what may be described as 'non-com- metrical' considerations.

11. Dr. Jalan, Governor of RBI has given the following arguments in support of privatisation of the banking sector:

(i) " Indian legal system provides" full protection to the private interests of the public servant' including in the banks and further public sector banks have been afflicted with management by non-commercial' considerations. He believes that accountability to the shareholders will make sure that the officers stay on course.

(ii) Poor internal control and risk-management systems of the banks; and greater accountability on the part of corporate."

(iii) India should increase its domestic savings and invest them in the services sector to emerge a leader in the world economy. He also quotes W. Arthur Lewis to the effect that the central fact of economic development is that of capital accumula­tion and that would require an increase in the rate of domestic savings from 4 per cent to 12 per cent.

India has failed to accumulate capital despite having secured such an increase in domestic savings because till the 1980s, the state-controlled financial system acted "as deposit-taking agencies and providers of credit and finance for designated and centrally determined purposes...the public sector - instead of being a generator of savings for the community's good - became, over time, a consumer of community's savings".

Arguments against Privatisation

1. One of the Directive Principles is that the Government would strive at redistributive justice in the country. Bank privatisation is a step away from this direction.

2. Public sector banks in India have already been exposed to increasing competition. The forces of competition have already pushed Public sector banks to optimize its resources in order to reach technical efficiency. It is felt that conclusions are being drawn on the basis of incomparable units - all of this to favour privatisation and even foreign ownership.

3. Privatisation opens the way for the domination of the economy by foreign capital. Since it is extremely difficult to distinguish in practice between domestic and foreign capital within the private sector when they are operating together in joint ventures, or when a domestic firm can be a front for foreign capital, any expansion in the scope for the private sector necessarily enlarges the sphere of operation of foreign capital as well.

4. Privatisation would remove a large chunk of the economy from the purview of public scrutiny and hence from the realm of social accountability. A basic distinction be­tween public and private property consists in the fact that the former, in principle, is so­cially accountable, and this is enforced through Parliament and its committees.

How well this job is done is a separate issue? If it is badly done then that requires reforms in a different sphere. But privatisation puts an end to this form of social accountability and hence consti­tutes in a fundamental sense an abridgement of democracy.

5. Social accountability is not merely intrinsically desirable. It becomes absolutely nec­essary when enterprises have to fulfill certain social functions going beyond mere profit- making. Privatisation, and even making public enterprises concentrate exclusively on profit- making, effectively does away with these social functions.

6. All privatisation involves the selling of state property at "throwaway" prices. This is true the world over. And it has been true in India too as the Comptroller and Auditor- General's report pointed out some time ago.

In other words, in privatizing enterprises the state is not merely changing the form of its property from enterprises to schools or hospitals or reduced public debt but is transferring gratis some state property to private monopolists.

Since state property has been built up through the sacrifices of the common people through tax payments or inflation-induced restraints on consumption, privatisation amounts to an implicit act of plunder, or what Marx called "primitive accumulation of capital": a few are being allowed to filch from many through the courtesy of the state.

7. India has been a planned economy for the last about five decades. But in absence of any effective control over the commercial banks, the economic planning was incomplete and monetary policy targets were difficult to achieve and pursue.

With the nationalization of banks, the government could actually plan and pursue the monetary policy targets and it would be wrong to say that the decision of bank nationalization was a mistake.