The full-fledged recovery of India's banks hinges on privatisation and mergers

Overseeing 21 public sector banks has proven too difficult a task for the government.

Privatisation and consolidation may just hold the key for the full-scale recovery of embattled Indian public sector banks as their staggering bad loan problem highlighted systematic flaws in their existing banking structure and governance. 

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This comes after state-owned Life Insurance Corporation (LIC) bought controlling stake (51%) in debt-ridden IDBI Bank after the government reportedly failed to find a suitable buyer from the private sector.

Although the insurance regulator and the union cabinet have greenlit the deal, it has yet to be cleared by the central bank and still pending a formal communication from the finance ministry to IDBI Bank.

IDBI Bank has been one of the worst-performing state owned lenders with gross NPAs at around 27.95% as of end-March, according to the Indian Express.

“Mergers amongst the PSBs would be credit positive for them because they would give scale efficiencies to the remaining enlarged banks. They would also help improve corporate governance,” credit rating agency Moody’s said in a report.

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The government is reportedly resuming discussions on public sector bank consolidation with larger players like Bank of Baroda, Canara Bank, and Union Bank of India being eyed as absorbing smaller lenders.

The task of overseeing the country’s 21 public sector banks (PSB) is proving to be too unwieldy for the government, added Moody's, as the Modi administration has already shelled out $30.07b (INR2.1t) to recapitalise weakened state lenders after their massive bad loan problem came to light.

PSBs have incurred a massive $3.81b loss owing to fraud in the financial year 2017-18, according to a Right to Information reply, with PNB accounting for the lion's share of losses after diamond merchants took off with $2b in fraudulent loans. In Q1, PSBs also booked over $9b in losses due to the central bank's tighter nonperforming loan rules.

Such task has occupied the government’s attention to the extent that it has been unable to pay sufficient attention to other key issues like long-term strategies and human resources, added Moody’s.

Outgoing chief economic adviser (CEA) Arvind Subramanian has also backed proposals to cut down on the unnecessary weight in India’s bloated public banking sector. "India should have just three to five public sector banks and as many private sector banks," he said in an interview to ToI.

"I think there should be more private sector banks and probably fewer banks. A healthy system is where we have three to five public sector banks, three to four private sector banks and one or two foreign banks," he added. 

Additionally, the International Monetary Fund (IMF) is the latest to support proposals pushing for the privatisation of India’s sickly banking sector. “A first step would be to strengthen the quality and independence of these banks’ boards, and privatisation could also eventually be considered,” the IMF said in a statement.