ISSN (Print) - 0012-9976 | ISSN (Online) - 2349-8846

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Public Sector Banks Are Adrift

With credit and deposit growth slowing in key sectors and only retail credit growing, low capital adequacy ratios of banks, senior management changes in the offi ng, and bank mergers, the National Democratic Alliance government needs to ask itself what it envisages for public sector banks, and indeed for the Indian economy.

India’s public sector banks (PSBs) are in a state of drift of the sort we have not seen in the past two decades. Credit and deposit growth at PSBs have slowed down sharply. Many of the PSBs are poorly capitalised. They face a serious erosion in senior and top management in the next two or three years.

What do these bode for the economy? What role does the National Democratic Alliance government envisage for PSBs? These are among the most pressing policy issues that the government has to face up to. If the government has a view on these matters, it is keeping it strictly to itself.

Slow Credit and Deposit Growth

Let us begin with credit growth. There is a perceptible slowing down of credit and deposit growth in the banking system. The deceleration is driven overwhelmingly by the slowdown in growth in PSBs (Table 1).

Bank credit growth slowed from an annual rate of 13.2% in June 2013 to 9.4% in June 2016. Deposit growth came down from 13.5% to 9.2%. In the years preceding 2013, credit had grown for several years in the range of 18%–20%.

PSBs and private banks exhibit divergent trends in credit growth. In the State Bank of India (SBI) group, the deceleration is relatively modest, from 15% to 9.7%. At nationalised banks, credit growth is down to 1.4%. One would suppose that in some banks, the balance sheet has shrunk. These trends are mirrored in deposit growth at PSBs.

At private banks, credit growth has spurted from 17% to 25.9%. This cannot be ascribed merely to the lower base at private banks in 2013, their base was even smaller but they were growing at just 2 percentage points more than the SBI group.

The correlation between growth in bank credit and gross domestic product (GDP) appears to have broken down in recent years. As Table 1 shows, credit growth was higher in 2013 than in 2016 but the growth rate of the economy was lower in 2013 than in 2016.

We have an explanation for this phenomenon: the importance of bank loans in overall credit has been falling (Mundra 2016). Non-banking financial companies (NBFCs) are providing more credit than before. Banks themselves are making funds available to companies in ways other than loans, such as investment in corporate debt instruments or commercial paper. So are others such as mutual funds. It is total credit deployment we should look at, not just bank credit.

The share of banks in total credit deployed (by both banks and non-banks) has fallen from 84% in 2014 to 80% in 2016 (Table 2). Should we expect this trend to continue, so we do not have to worry too much about the deceleration in credit growth at PSBs? Maybe the industry will find other ways to meet its credit needs.

One should be careful not to jump to conclusions. Today, banks may have to compete with mutual funds and others in investing in commercial paper and corporate debentures even though the yields are low. However, defaults in these instruments could cause the current trend to reverse quickly. Then, the deceleration in bank credit could become a serious problem.

No Credit Growth in Key Sectors

Moreover, the sectoral deployment of credit matters, not just the trends in aggregate credit (Table 3, p 11). Non-food credit growth decelerated from 13.5% in 2013 to 9.1% in 2016. The deceleration in credit to industry was even sharper, from 15.1% to 2.8%. Personal loans (a category that encompass various kinds of retail credit) accelerated from 14.7% to 19.4%.

The Reserve Bank of India (RBI) website provides aggregate data for sector-wise credit, but it does not provide the data by bank category, that is, PSBs, private banks, etc. We have indications of the trends in each category from another source (Rajan 2016). In April 2016, private sector credit growth to industry (which tends to be mostly short-term loans) was over 20%. PSB credit growth to industry had turned negative. Growth in retail at PSBs has been converging towards that in the private sector.

Now, we get the picture. Not only has credit growth decelerated, it is being driven by retail loans and short-term loans to industry, not lending for investment. This was always true of lending by private sector banks. Today, PSBs too have veered towards retail loans. In the boom period of 2004–08, PSBs had borne the burden of project finance. The shift in lending priorities at PSBs is worrying.

Retail finance and short-term loans may sustain economic growth as long as there is unutilised capacity in industry. Over the longer term, however, we need credit for investment to revive. RBI deputy governor S S Mundra (2016) believes that overall credit growth needs to be in the range of 12%–15% in order to sustain our medium-term growth targets. It is hard to see this happening without a revival in long-term credit to industry by PSBs.

Low Cost of Recapitalisation

What is keeping PSBs from stepping up credit to industry, especially project loans? Lack of capital is undoubtedly the biggest factor. The capital adequacy ratio at PSBs is currently 11.82% compared to 15.68% at private banks.

The average for PSBs masks differences among various banks. Some nationalised banks may be operating close to the minimum prescribed level of 9%. For banks to be able to take risks with lending to industry and especially with project finance, they need a cushion of at least 4 to 5 percentage points above the minimum. This means they should be having a capital adequacy of around 13%–14%.

The principal failure today is thus of adequately recapitalising PSBs. Many PSBs are in no position to raise equity capital from the markets. The government, for its part, is unwilling to provide the necessary capital. We keep hearing that the government does not have the fiscal space to provide the necessary capital. This contention needs to be squarely refuted.

First, the government does not have to infuse cash from its budget. It could subscribe to PSBs’ equity and the banks could invest the proceeds in Recapitalisation Bonds offered by the government. In the year in which such an exchange takes place, the government bonds are not treated as part of the fiscal deficit. It is the interest payment in future years that counts towards the fiscal deficit.

Second, the fiscal cost of recapitalisation in India—less than 1% of GDP in over two decades—is probably the lowest in the world, so we can afford to spend more.

Third, recapitalisation in the past has served to improve the government’s own returns from PSBs, so recapitalisation is not “money down the drain.”

Fourth, the cost of recapitalisation must always be weighed against the loss of economic output on account of inadequate credit.

Management Needs Attention

Turn now to the third issue at PSBs today, the impending wave of exits at the top management level. One post of chief executive officer (CEO)/chairman and managing director (CMD) is lying vacant at the moment. In 2017, eight retirements of CEOs/CMDs are due and another 10 retirements are due in 2018. At the executive director (ED) level, five retirements are due in 2016, seven in 2017, and 10 in 2018. More than 73% of staff in deputy general manager/general manager cadre are over 55 years of age (Mundra 2016). The neglect of succession planning, which has happened over several years, is now showing up.

We do not see the requisite urgency in tackling the issue of managerial manpower. The immediate challenge is to select persons to fill the top management vacancies and give them a clear mandate to plan for vacancies down the line. The Bank Board Bureau (BBB) has been tasked with recommending names for the posts of CEO/CMD and ED with the final decision vesting with the government. The entire process appears to be taking longer than it should, else we would not be seeing a CEO-level vacancy at a PSB.

The BBB is said to be asking for the power to make appointments of CEOs and independent directors to be devolved to itself, as recommended by the P J Nayak Committee in 2014. There is also a clamour for appointments to be devolved further to the boards of PSBs themselves.

These changes are unlikely on past record. If they do happen at all, it will be over a very long period. Until then, the onus is squarely on the government to expedite appointments of top management as well as of independent directors.

It is hard to miss the broad message underlying the state of drift at PSBs. The government appears to have concluded that the best way to deal with the governance challenges posed at PSBs is to reduce the number of PSBs. That would, in principle, leave the government with fewer PSBs, and stronger ones at that. If this means that the market share of PSBs in bank credit and deposits must fall, so be it.

The dangers in this approach should be obvious. Over the medium term, credit growth may not be adequate and there may not be enough credit for industry and infrastructure. Reducing the number of PSBs through mergers could end up weakening, not strengthening, PSBs. The government needs to ask itself a basic question: can an economy grow at 8% when 70% of the banking system is left to muddle along?


Mundra, S S (2016): “Setting the Priorities Right,” address at the 3rd SBI Banking and Economics Conclave, 28 September, Mumbai.

Rajan, Raghuram G (2016): “Policy and Evidence,” address at the 10th Statistics Day Conference 2016, Reserve Bank of India, 26 July, Mumbai.

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