India’s banking sector has historically been dominated by public sector banks. These banks have statutory limitations on their operations that can depress profitability and can leave them with nonperforming loans on their balance sheets.
A new generation of private sector banks in India has grown up to challenge these government-owned banks, using digital tools to appeal to younger, technologically savvy consumers. As the balance in India starts to tip to the private sector, some public sector banks may be privatized.
Prime Minister Narendra Modi’s government uses the slogan “minimum government, maximum governance” to support its efforts to open up the Indian economy through privatization within a regulatory framework.
To strengthen the country’s public sector banks prior to any attempt at privatization, the government consolidated the 27 public sector banks that existed in 2017 to 12 in 2022. These banks continued to command the lion’s share of the market, holding 63% of customer deposits.
Although the government canceled plans to privatize two public sector banks in 2022, S&P Global Ratings believes that this process would ultimately improve system efficiency. However, India’s central bank reignited debate over bank privatization by publishing a paper critical of the government’s plans.
This paper suggested that public sector banks, by offering credit to industry and agriculture, perform a vital role in Indian society that is more important than profit maximization alone. The timing of the paper is interesting since India’s supreme court recently reinforced regulatory oversight of the Reserve Bank of India over nonbanking financial companies, which are private enterprises.
While the paper credited private sector banks as being “more efficient in profit maximization, their public sector counterparts have done better in promoting financial inclusion.”
The Reserve Bank of India paper may be a response to one published in July by economists Arvind Panagariya and Poonam Gupta for the India Policy Forum. This argued the government should privatize all state-owned banks, except State Bank of India.
Privatization partisans point to $66.67 billion the government gave to public sector banks over the past decade to help them deal with nonperforming loans on their balance sheets. The government continues to mandate loans toward “priority sectors” within the Indian economy, which make up about 40% of total loans.
According to S&P Global Ratings, anticipated economic growth should drive down the percentage of the weakest loans held by Indian banks to between 5% and 5.5% of gross loans by early 2024.
A further restraint on public sector bank profitability is that these banks are required to invest 18% of their net demand and time liabilities in government securities. The drag this creates for earnings is being somewhat alleviated, however, as yields on government bonds increase.
One argument for more private sector banks in India is that they aren’t as weighed down by maintaining an extensive network of bank branches. But many private banks are increasing their branch numbers, according to S&P Global Market Intelligence. Private banks have led in bringing digital banking to young consumers, but many bank customers in India prefer the comfort and security of a physical branch.
Given India’s enviable growth rate and comparatively mild inflation, its banks are well placed to ride a demographic boom over the next decade. If the government intends to continue the privatization drive, this may be the opportunity.
