Capitalization of Public Sector Banks based on their Efficiency-An Evaluation


Dr Lekshmi Nair*

As a part of the Indhradhanush plan for revamping the Public Sector Banks (PSBs), the Union Finance Minister Arun Jaitley, in August this year, announced the decision to infuse capital selectively into PSBs. The scheme is based on two efficiency parameters namely Return on Assets and Return on Equity. Based on this, only nine PSBs were allocated capital considering their better performance in the recent times. It is claimed that this will incentivize PSBs to improve their performance and reduce the monopoly enjoyed by the PSBs in the loan market. This in turn is claimed to improve the performance of the banking industry in India. This article tries to understand whether these claims will materialize or not.

The government contributed around Rs 900 Billon from 1985-86 to 2013-14 to the public sector banks for their capitalization purposes without any market tests with a return of only Rs 18 Billion. On the other hand, private banks have to satisfy some criteria like the efficiency of capital use and cost, profitability and its sustainability, management team quality, etc. The access to unlimited resources, without any of these market tests, has resulted in the inefficient behaviour of the PSBs hurting the overall banking industry. This has resulted in the decision of Government in August 2015 to link capital infusion to the public sector banks (PSBs) with their efficiency and performance as stated above. Governments decision is to infuse Rs 6990 Crore to nine PSBs only including State Bank of India, Bank of Baroda, Punjab National Bank, Syndicate Bank, Canara Bank, Allahabad Bank, Indian Bank, Dena Bank and Andhra Bank, based on the two efficiency parameters, leaving the weak banks among the PSBs short of money. It is claimed that this move can help in incentivizing the PSBs to improve their performance.

The two parameters considered by the Government namely Return on Assets and Return on Equity indicate the profitability of banks. At the same time, however, profitability cannot be considered as the only criterion for PSB performance. This is because, rather than profitability, PSBs were established for larger public policy objectives like increasing the financial inclusion and the lending to priority sector.

Reserve Bank of India reports, however, show that the priority sector credit from the PSBs as a percentage of all bank priority sector credit has shown a decline over the period 2001 to 2014.  At the same time, the priority sector credit from private banks and foreign banks as a percentage of the total bank credit to the priority sector increased significantly over this period. This shows the PSBs’ failure to achieve one of its main objectives namely priority sector lending.

The reports on the financial sector inclusion in India and the NSSO data   show that   in spite of the significant rise in the number of bank offices in rural areas of the country, there is only limited access to institutional credit by the  small and marginal farmers. Around 51.4 % of the farm households in India do not have access to credit from either institutional or non-institutional sources, as shown by the NSSO 70th round information. Moreover, most of the farm households who have access to credit still depend on informal sources of credit. The scenario indicates the low level of financial inclusion in India, in spite of the nationalization of banks designed to achieve this objective in 1969.  PSBs in India   have thus failed to achieve their broad objectives of priority sector lending and increasing the financial sector inclusion, indicating their inefficiency.

Private Banks still have to satisfy many stringent criteria for raising capital from investors compared to PSBs. In spite of privileges granted to the PSBs compared to their private sector counterparts, they are found to be lagging behind the private banks in terms of all dimensions of performance management and efficiency, as shown in different studies like asset growth, operational efficiency, human capital quality and newer technologies adoption in the recent years.   In recent years, the new private banks are enjoying a preference over the PSB by the investors from abroad. The data available in the public domain shows that through the infusion of huge amount of money to the PSBs by the government, the taxpayers’ money is being used for investments, which are very unproductive and inefficient.

Adhoc decisions like the one to infuse capital based on two parameters of efficiency will not create any incentive for PSB to improve their performance. The savings of the investors will still be channelled into investments that are not productive. Two alternative solutions can be suggested for this. The criteria for capital infusion need to be made equal for both PSBs and the private banks. There will be healthy competition in the banking industry through this solution. The PSBs, will in turn, be incentivized to improve their performance.

Alternatively stop the capital infusion to the PSBs. The access to unlimited resources to the PSBs will be limited through stopping the capital infusion. The taxpayers’ money should be used for other immediate and competing purposes. In this case, for the PSBs with sound market values of equity, the recapitalization needs to be done on deep discount right issues. This, in turn, will create a burden on the shareholders rather than the taxpayers over time.


*The author is Senior Researcher with Centre for Public Policy Research, Kochi. Views expressed here are personal  and does not reflect or anyways represent the views of Centre for Public Policy Research.

Dr. Lekshmi Nair

PhD in Economics, M. Phil in Applied Economics from JNU/CDS Trivandrum and Masters in Statistics

Dr. Lekshmi Nair

Dr. Lekshmi Nair

PhD in Economics, M. Phil in Applied Economics from JNU/CDS Trivandrum and Masters in Statistics

You may also like...

Leave a Reply

Your email address will not be published. Required fields are marked *