News & Analysis

RBI for Gradual Withdrawal of State Control on PSU Banks

The alternate view was presented by the Central Bank via a strategy note penned by its in-house research department

The Reserve Bank of India has expressed a word of caution on adopting what it called a “big bang” approach to privatization of public sector banks, claiming that it could potentially do more harm than good. Instead, it sought a more gradual withdrawal of state control over these large lending institutions. 

These comments come in a thought paper (download it here) written by the RBI’s banking research division in the department of economic and policy research. However, there was the usual disclaimer on the research paper that the views expressed were those of the authors and do not necessarily reflect the views of the RBI. 

The note said privatization is not a new concept and its pros and cons are well known. From the conventional perspective that privatization is a panacea for all ills, economic thinking has come a long way to acknowledge that a more nuanced approach is required while pursuing it. 


Slow and steady is the call 

“The government has already announced its intention to privatize two banks. Such a gradual approach would ensure that large scale privatization does not create a void in fulfilling important social objectives of financial inclusion and monetary transmission,” says the article written by Snehal S Herwadkar, Sonali Goel and Rishuka Bansal. 

Earlier this year, Finance Minister Nirmala Sitharaman had announced in Parliament that the government plans to reduce stake in two public sector banks though no timeframe was mentioned. Now, the article claims evidence that since PSUs aren’t entirely guided by profits, the financial inclusion goals continue to have an impact on the overall economy. 


PSU banks are mending their ways

“Our results also point out the countercyclical role of public sector bank lending. In recent years, these banks have also gained greater market confidence. Despite the criticism of weak balance sheets, data suggests that they weathered the covid-19 pandemic shock remarkably well,” says the report. 

It further notes that the recent merger of 10 PSU banks consolidated the sector, creating robust and competitive banks, with the National Asset Reconstruction Company (NARCL) helping to clean up the legacy burden of bad loans from bank balance sheets. Overall, these reforms would help strengthen the PSU banks further, the report said. 

Pointing to the high ratio of PSU bank branches in rural and semi-urban areas, the report said these institutions help meet the credit demand in the hinterland. “It is often argued that private banks (PVBs) meet their priority sector lending target of 40% fully and thus contribute towards financial inclusion. Granular data, however, show that the PVBs have met their priority sector targets not through organic lending but through investment in priority sector lending certificates (PSLCs), especially in agriculture and small and marginal farmers categories,” it added. 

The report also questioned the efficiency levels of banks in India between 2010 and 2022 and claimed that when profit maximization was the sole objective, private banks performed better than PSU banks on efficiency. However, when the objectives included financial inclusion, the state-owned lenders were more efficient. 

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