The PSU Banking Crisis: Message from the Market

By Dr. V. K. Vijayakumar

Next year would be the 50^th year of bank nationalization – a major economic policy decision taken by Indira Gandhi in 1969. It was hailed as a progressive decision by many sections of the society even though many economists and finance experts had questioned the economic logic of nationalization. Indira Gandhi and those who supported nationalization defended the decision by arguing that these banks were lending only to the rich and not to the broader sections of the society and that nationalization would change this. 49 years after nationalization, the nationalized banks are in very bad shape by lending money without due diligence.

SBI came into existence in 1955. 14 banks were nationalized in 1969 and 6 more in 1980. Bank nationalization led to explosive growth of banking in India benefiting large segments of people. However, political influence and irresponsible lending did irreparable damage to PSU banks. By 1994 mounting NPAs completely wiped out the capital of 13 nationalized banks and NPAs touched 24 percent endangering the very existence of the banking system. PSU banks were back in business only with massive recapitalization by the government at the expense of the taxpayer. Recapitalization and the implementation of Narasimham committee recommendations by the Narasimha Rao government saved the Indian banking system.

In recent times, the UPA 2 infused Rs 60,000 crores as fresh capital in the PSU banks. In 2015 the Modi government announced Rs 70,000 crores of capitalization, out of which, Rs 50,000 crores have already been given. As the NPA problem mounted, in a major recapitalization drive in October 2017, the government announced a huge infusion of Rs 1,35,000 crores. In brief, during the last 10 years, the PSU banks have been allocated a massive Rs 2,65,000 crores.

The market is sending an important message

Market signals are hugely important. Market valuations (market capitalization) of private sector banks are significantly higher than those of PSU banks. Of course, private sector banks also have NPA issues. But the ratio of NPAs to total loans of PSU banks is 3 times higher than that of private sector banks. The market recognizes and rewards this superior governance of private banks. The market capitalization of HDFC Bank (incorporated in 1994) is higher than the combined market capitalization of all nationalized banks and SBI put together. The market value of Kotak Mahindra Bank (incorporated as a bank in 2003) is equal to the combined market value of all nationalized banks, excluding SBI. Recently Kotak Mahindra Bank overtook SBI in market capitalization. The market cap of the 9-year old NBFC Bajaj Financial Services is higher than the combined market cap of 14 nationalized banks with decades of history. The market rewards governance and punishes misgovernance.

The shares of 18 nationalized banks are quoting at substantial discount to their book value. Contrast this to the valuation of private sector banks, which are quoting at several multiples of the book value. HDFC is quoting at more than 3 times book value and Kotak Mahindra Bank is quoting at 6 times book value. The market is rewarding superior governance, management quality and the future growth prospects of these better-managed banks.

The potential

Banking is a play on the economy. As the economy grows, the demand for financial services will grow disproportionally. The best days of Indian banking are yet to come. There is a near consensus that the Indian economy will grow from the present $2.4 trillion to around $ 7 trillion or more by 2030. The growth in Indian banking, particularly private sector banking, will be disproportionally higher. The market cap of the Indian banking industry – public and private sector banks put together – is around Rs 12 trillion. This is less than half of the market cap of the largest US Bank J P Morgan, which has a market cap of $ 400 trillion. This gives an indication of the potential for growth for the Indian banking industry.

Private sector banks will expand market share

There are governance issues in private sector banks too. But it is a fact that governance and performance are better in private sector banks compared to PSU banks. Going forward, the private sector banks will grow faster than PSU banks. There is no other large economy in the world where government owns 70 percent of the banking system. With better regulation private sector banks can perform much better than PSU banks. But this doesn’t mean that they are free from scams and corruption. Globally, there have been many instances of private bank failures. The collapse of the investment bank Lehman Brothers contributed hugely to the global financial meltdown of 2008. The big scams in Royal Bank of Scotland, Barclays Bank and Bearings Bank are recent instances of private bank scams caused by greed and corrupt practices.  Therefore, more than ownership, the issue should be control and regulation.

Bankers should not be targeted

An unfortunate fall out of the PNB scam is that there is unjustified criticism and witch- hunt of bankers. In their enthusiasm to catch the culprits and punish the guilty, the Enforcement Directorate and regulators should not scare the bankers into inaction. NPAs are part of banking business. 2 percent NPA is treated as normal in banking. It is important to distinguish between willful defaulters and defaults arising out of business failures. The former has to be brought to book and punished. In the process, if bankers are threatened with action for NPAs arising out of business failures, they will turn excessively cautious in lending. This regulatory overkill would slowdown investment and economic growth. India is presently on the cusp of economic growth recovery and investment is picking up. Over enthusiasm by the law, enforcing agencies and regulators should not kill this recovery in investment and growth.