The Centre should privatise all public sector banks (PSBs), except the State Bank of India (SBI).
This is because private banks have emerged as a credible alternative to PSBs with substantial market share.
Also, government ownership hinders the ability of the Reserve Bank of India (RBI) to regulate the sector, according to a report by the National Council of Applied Economic Research (NCAER).
Barring SBI, most other PSBs have lagged behind private banks in all the major indicators of performance during the last decade.
They have seen soured loans and operational costs soar, the report authored by NCAER’s Poonam Gupta and economist Arvind Panagariya said.
These PSBs have also attained lower returns on assets and equity than their private sector counterparts.
PSBs have lost ground to private banks, both in terms of deposits and advances of loans.
Since 2014-15, almost the entire growth of the banking sector is attributable to the private banks and the SBI, it said.
“The under-performance of PSBs has persisted despite a number of policy initiatives aimed at bolstering their performance during this period.
"These initiatives are recapitalisation, constitution of the Bank Board Bureau to streamline and professionalise hiring and governance practices; prompt corrective action plans; and consolidation through mergers, which helped reduce their number from 27 in 2016-17 to 12 currently,” the report said.
The non-performing assets (NPA) of PSBs remain elevated as compared to private banks even as the government infused $65.67 billion into PSBs between 2010-11 and 2020-21 to help them tide over the bad loan crisis.
The market valuation of PSBs, excluding SBI, remains “hugely” below the funds infused in such banks as May 31, 2022.
“Meanwhile, private banks have sped ahead by miles in terms of market valuation.
"The steady erosion in the relative market value of PSBs is indicative of a lack of trust among private investors in the ability of PSBs to meaningfully improve their performance,” the report said.
The market cap of PSBs, except SBI, is about $30.78 billion as compared to the recapitalisation amount of $43.04 billion.
The report suggests that the first two banks chosen for privatisation should be the ones with the highest returns on assets and equity, and the lowest NPAs in the last five years.
It also said that the PSBs with lower government ownership would be easier to privatise.
This is because the first two banks chosen for privatisation should set an example for the success of future privatisations.
The markets must see value in the chosen banks to attract two or more buyers.
Even as NITI Aayog suggested privatisation of the Central Bank of India and Indian Overseas Bank, the report recommends Indian Bank and Bank of Baroda as the two top choices for privatisation.
These two have been shortlisted based on the criteria of return on assets, return on equity, NPAs, government stake, and asset base.
Between these two, Bank of Baroda would be easier to privatise since the government will need to divest by only 15 percentage points to lower its stake below 51 per cent.
Suggesting the sale strategy, the authors have stated that if the Centre chooses to keep its stake near the 50 per cent cap, it can sell its shareholding in the open market on the 15th of each month to lower its stake to 50 per cent.
“The commitment will have the immediate impact of raising the share price in the market, and as the government makes good on its commitment, the price will move towards its expected post-privatisation level.
"The government will thus be able to reap much of the benefit of the higher post privatisation price on the shares it chooses to divest,” it said.
The second would be selling to a large strategic buyer or a consortium of buyers.
However, this would lead to one constraint in seeking a single large buyer.
This is because the current regulations require the shareholding by a single entity to be brought down to 26 per cent or less within 15 years of initial acquisition.
If the government takes this route and needs to divest 30 per cent stake or more, it may have to look for a consortium of buyers.
Or, it has to sell some shares in the market to retail investors beforehand, according to the report.
NCAER also makes a case for corporate ownership in banks with due diligence as there is “scarcity” of potential large-scale investors in banks.
The government must allow foreign investors, including foreign banks and domestic investors, as well as corporate houses to enter the auctions with due diligence, the report said.
“Any potential risk associated with corporate ownership or foreign banks may be minimised by letting a consortium of corporations enter the bidding with the stake of any single corporation capped.
"It would ring-fence the Indian banking operations of a foreign firm through appropriate regulation and supervision,” it added.