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The Business of Government Should Not Be Business

Feb 26, 2018


The government of India owns 21 public sector banks. We have been advocating over the years that the government doesn't really need to own so many banks. It just adds to the economic mess.

In the aftermath of the Nirav Modi fraud, many other economists, businessmen and analysts, have been making this rather obvious point.

The finance minister Arun Jaitley ruled this out recently, when he said: "This (privatisation) involves a large political consensus. Also, that involves an amendment to the law (Banking Regulation Act). My impression is that Indian political opinion may not find favour with this idea itself. It's a very challenging decision."

The total bad loans of public sector banks as on September 30, 2017, were at Rs 6,89,806 crore. The bad loans rate was at 13.5% i.e. of every Rs 100 lent by public sector banks, Rs 13.5 had not been repaid by the borrowers.

The Nirav Modi fraud is pegged at $1.8 billion (or around Rs 11,400 crore). If the total Rs 11,400 crore is assumed as a bad loan, then the total bad loans of public sector banks will be a little over Rs 7,00,000 crore. Hence, the fraud is simply a drop in the ocean of bad loans of public sector banks.

This means that the problem is somewhere else. If we look at data as of March 31, 2017, the total bad loans of public sector banks were at Rs 6,19,265 crore. Of this around 69% or Rs 4,24,434 crore, was on account of lending to corporates. And this is where the problem lies.

One Nirav Modi and his companies are not the problem, it is the corporate sector as a whole which has been abusing the public sector banks in the country.

Of course, with such a huge amount of bad loans, the government has to constantly keep infusing capital into the public sector banks, in order to keep them going.

The hope is that with the government infusing money into these banks, they will gradually get back to full-fledged lending and in the process help the economy. Of course, there is nothing wrong with this hope but the economic incentive it creates for politicians, is totally different.

As Thomas Sowell writes in Basic Economics-A Common Sense Guide to the Economy: "Nothing is easier than to have good intentions but, without an understanding of how an economy works, good intentions can lead to counterproductive, or even disastrous, consequences for a whole nation. Many, if not most, economic disasters have been a result of policies intended to be beneficial-and these disasters could often have been avoided if those who originated and supported such policies had understood economics... [There is a] crucial importance of making a distinction between intentions and consequences. Economic policies need to be analysed in terms of the incentives they create, rather than the hopes that inspired them."

Long story short-while implementing an economic policy, we need to be able to differentiate between what the policy hopes to achieve and the economic incentives it creates. It is ultimately, the economic incentives that are created which will decide how people react to the policy, making it effective or ineffective.

A major reason why politicians love the idea of owning public sector banks (or public sector enterprises for that matter), is that it allows them to bestow favours on their favourite industrialists (read crony capitalists).

In terms of public sector banks, this means forcing them to give out loans to businessmen, who either are not in a position or do not have any intention of repaying the loan. Hence, the government may be recapitalising banks with the hope of letting them operate at their full strength, but the real incentive for the politicians is somewhere else.

The only way of breaking this nexus between businessmen and politicians, is to privatise a bulk of the banking sector in India. If that is not possible due to regulatory hurdles (as Jaitley talked about), a bulk of public sector banks should not be lending to corporates. There activities should be limited to raising money as deposits and lending them out in the form of retail loans.

This "narrow banking" model is likely to work better simply because with a bulk of public sector banks not being allowed to give corporate loans, the politicians will not be in a position to direct lending towards their favourite corporates. With this taken out of the equation, public sector banks might just about manage to operate much more efficiently.

Also, with politicians having one lesser issue to deal with, they might just pay more attention to the other major problems that the country faces and get their heads together on tackling them.

The trouble is that the decision to get public sector banks out of lending to corporates, is to be made by politicians. And as we saw in the column, they do not have an incentive to do anything like that. How do you deal with a problem like that?

Warm Regards,

Vivek Kaul
Editor, Vivek Kaul's Diary

Vivek Kaul is the Editor of the Diary. He is the author of the Easy Money trilogy. The books were bestsellers on Amazon. His latest book is India's Big Government - The Intrusive State and How It is Hurting Us.

Disclaimer: The views mentioned above are of the author only. Data and charts, if used, in the article have been sourced from available information and have not been authenticated by any statutory authority. The author and Equitymaster do not claim it to be accurate nor accept any responsibility for the same. The views constitute only the opinions and do not constitute any guidelines or recommendation on any course of action to be followed by the reader. Please read the detailed Terms of Use of the web site.

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10 Responses to "The Business of Government Should Not Be Business"

R Varadarajan

Mar 3, 2018

The biggest problem is that the country is run by politicians and not by economists. Even those having economic background, forget the basic economics when they join the Govt. After all, the elections are won by populist gimmicks and efficient and effective mud- slinging and by economic policies. Unfortunately, the Banks are one departments where the rot has caused immense financial loss to the country and there seems to be little respite from banking scams and bad loans. Unless an 100% efficient and transparent audit is conducted at 100% of the branches, we may keep getting more cases like Nirav Modi, day in and day out. Only the type of fraud and the quantum may vary. The quantum of bad loans has already over shadowed the 2G scam which is touted as the largest scam in the recent past. I fully agree with Mr Vivek Kaul and the Govt should get out of the banking business and privatize them which alone can imbibe accountability !!!


Syed Taffazull Hussain

Feb 27, 2018

Public sector banks have done yeoman service in the past in reducing inequality. A better solution would be to reduce the number of Public Sector banks by mergers and restrict the maximum amount they can lend to one entity to less than Rs.100 crores so that only small and medium scale sector is catered to by them. Lending of sums above Rs 100 Crores to big Corporates may be left to big Private banks or specialised institutions both Public and Private.



Feb 26, 2018

"The only way of breaking this nexus between businessmen and politicians, is to privatize a bulk of the banking sector .. trouble is that the decision to get public sector banks out of lending to corporates, is to be made by politicians .. and they do not have any incentive to do anything like that."
This sums up the 'problem'. 'How do we reduce/minimise the endemic problem of repeated buildup of bad debts in PSBs leading to the need for repeated re-capitalisation at taxpayers expense?'
Trouble is, this not the REAL PROBLEM at all; because we already have the answer to it - privatise; a solution we have known for decades!
The REAL problem is - 'How do we take the power of making this decision, out of the hands of the politicians, and where do we put it?'
If Mr Kaul can suggest a workable answer to THIS problem, the issue of cyclical bad-debt build-up and recapitalisation - will be history!

Like (2)


Feb 26, 2018

PSBs should stop lending corporates.

Like (2)

G Vijayaraghavan

Feb 26, 2018

While the idea of Narrow Banking has some merit and will definitely help with bad loans of public sector banks, the root of the problem has not been addressed, and the problem is only being shifted to the private sector banks which will be unable to absorb bad loans and will quickly fold without the government budgetary support (being enjoyed by the public sector banks). The depositors become the losers and faith in the banking system will be eroded in short order. This has in fact happened with several NFBOs.

The main problem is that our judicial processes are slow and troublesome and private banks will be equally handicapped by wilful defaulters. The other problem is that when public limited companies take bank loans and do not pay them back, the nebulous entity called the 'company' is the defaulter whereas in fact the beneficiary is the controlling individual who diverts money from the company in connivance with the company auditors to his own wealth and assets, an example being King Fisher Airlines and Vijay Mallya who now claims (and according to the letter of the law he could be right) that he is NOT liable for these loans. Mechanisms will have to be devised to address these basic issues.

Like (2)

Muthuswamy N

Feb 26, 2018

With the corporate lending taken out of banks, how, even in normal circumstances , banks would survive? What you suggest would drive the banks faster down than next only to manipulations by politicians.

How about denying loans only to those who have the intention of cheating even while they are applying? I can hear you saying 'how it is possible to find these intentions?' We have the answer - a proven one. Banks can implement this even without a slight noise from anyone. Even the banks are not interested in our country because professional performance is harder compared to pleasing the bosses and politicians even for bankers.

Like (2)


Feb 26, 2018

The comment that "Private Corporate sector in INDIa is exploiting the Public sector for its own advantage " is correct and i would like to add further that it is happening with the active connivance of political set up from time to time. In other words, the people and the Country are the losers.

Like (1)

Pradeep Kumar Nair

Feb 26, 2018

How do you solve a problem like Maria?

Like (1)

Thiruvalluvan V

Feb 26, 2018

I agree fully to your view that PSU banks should be made not to lend loans to corporates.

I fully disagree with you to close down all the PSU banks since ordinary personnel who do not have any other means but to keep their money in banks will loose all the money if all are private banks.

All banks are same. The examples are the banks in Europe and in America. They are private banks. But their performance is much worse than our PSU banks.

Like (1)

Minaketan. Panigrahi

Feb 26, 2018

What I feel it is not the finance
to corporate sector is the problem .
Rather the meddling of ministers with political interest in pressurising banks for corporate
financing created this situation .
If banks finance only retail sector that may not be successful
profit generating model . Not only
Govt. Should withdraw from doing business but also create a condition which will help banks
for immediate recovery of bad loans . For that systemic changes
through legislation and stringent
implementation of law is needed .
As of now Govt has no intention at
all for privatising banks . This is clear from Mr. Jetley's remark .
That there will be no political
consensus is obvious . Govt banks
are a perennial resource and channel for political interest .

Like (1)
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