India Ratings and Research (Ind-Ra) opines that it is time to reevaluate the objectives of public sector banks (PSBs) and their role in the Indian economy. While the government has infused huge capital in PSBs, the same has largely been used to mitigate losses and has failed to contribute meaningfully to credit growth.


During FY14-FY19, the government and Life Insurance Corporation (LIC) together infused Rs 3 trillion in PSBs. However, from the value creation objective, the scenario looks weak.


The current market value as on 29 July 2019 of government and Life Insurance Corporation's stake was Rs 4.4 trillion (FY14: about Rs 2.2 trillion). The increase in market capitalisation over FY14 is significantly lower than the capital infused.


Nine of 19 PSBs reported current value of investment higher than the investment amount. The key banks among them are Indian Bank, State Bank of India, Bank of Baroda, and Canara Bank.


Over the years, the market share of PSBs in incremental credit generation shifted to other market participants including private banks, foreign banks, non-bank financial companies, housing finance companies and mutual funds. The market share of PSBs fell to 46.5% in FY19 from 60.9% in FY14. More importantly, in terms of incremental credit, the share of PSBs has been 26.2% over FY14-FY19.


The objective of nationalisation of banks included financial inclusion as the primary objective, along with increasing availability of credit to priority sectors such as agriculture and small and medium enterprises (SMEs). Due to stress of bad corporate loans in the system, the incremental credit to agricultural and SMEs segments by PSBs has been only 1.3x-1.5x of incremental credit to agricultural and SME segment by top 6 private banks (by the size of its assets) i.e. significantly lower than the share of PSBs in the banking system. Anecdotal evidence suggests PSB’s share in funding direct small ticket lending to agri and other priority sectors still remains high.

Recapitalisation is a prompt response to infuse funds in cash-strapped public sector banks. The capital infusion by the government in PSBs may ensure banks’ solvency but may not necessarily ensure stability and growth in the absence of non-financial and structural reforms.


Some of the structural changes that Ind-Ra believes should be implemented at the earliest include: 1) increase the tenure and prevent frequent changes in senior management team of PSBs as this does not allow for continuity in management policies and also reduces accountability; 2) include variable compensation and grant employee stock options to directly link the performance of the bank with the performance of the management team; 3) allow appointment of candidates from the private sector; some progress has been made towards this with the appointment of managing director and CEO for BOB, and more of this needs to be done to improve the management depth; 4) improve governance and increase independence of the board, 5) capability building and introducing compensation programmes in the staff to bring their drive for business at par with private banks, 6) use and adapt intelligent technologies to source business, manage loan workflows, reduce operating costs and reduce subjectivity in sanctions.


Without structural reforms in place, the government will have to continue to inject capital into banks in times of stress, which will strain its own finances and hinder efforts for fiscal consolidation.