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Mythology of Banking Ownership

The Reserve Bank of India's report, Trend and Progress in Indian Banking 2005-06 describes the success story of the Indian banking system and also challenges some conclusions on the issue of state ownership of banks. Contrary to the conclusions arrived at by several cross-country studies, the Indian banking system, despite maintaining significant state ownership, has increased bank productivity and efficiency, enhanced credit access, and is now in a sounder state.

Mythology ofBanking Ownership

The Reserve Bank of India’s report, Trend and Progress in Indian Banking 2005-06 describes the success story of the Indian banking system and also challenges some conclusions on the issue of state ownership of banks. Contrary to the conclusions arrived at by several cross-country studies, the Indian banking system, despite maintaining significant state ownership, has increased bank productivity and efficiency, enhanced credit access, and is now in a sounder state.


he recent Reserve Bank of India (RBI) report, Trend and Progress in Indian Banking, 2005-06 (Report, henceforth) brings out quite a few facts which not only spell out the success story of calibrated and well sequenced reforms in Indian banking but also force one to challenge some of the conclusions on the issue of state ownership of banks as reiterated in studies analysing cross country experiences.

A World Bank policy research report, concluded some years ago that “crosscountry and limited case study evidence shows that state ownership of banking leads to less development, less access to credit outside the largest firms, and a higher risk of crisis” [World Bank 2001:154]. The report found that “maintaining the status quo with significant share of staterun banks can be dangerous for the economy”. Similarly, the World Development Report [WDR 2002] concluded that “recent evidence indicates that greater state ownership of banks tends to be associated with lower bank efficiency, less saving and borrowing, lower productivity and slower growth” (p 85). Finally, the WDR 2005, reiterated that “having a large proportion of state ownership in the banking sector has been found to reduce overall access of financing, reduce competition, worsen the allocation of credit, and increase the likelihood of financial crisis” (p 117).

A limited point being made here is that contrary to the conclusions arrived at by cross-country studies, the Indian banking system, even after maintaining a significant state ownership, has gained soundness, increased bank productivity and efficiency and enhanced credit access. There has been no slowing down of growth and hence, any warning of an impending crisis is absolutely baseless. Notwithstanding a continuing dominant share by state-owned banks “the sustained efforts by the government, the Reserve Bank and by banks themselves have resulted in a competitive, healthy and resilient financial system. The asset quality and soundness parameters of the Indian banking sector, on the whole, are now comparable with global levels. This has been achieved against the backdrop of gradual alignment of prudential norms with international best standards and in an environment of growing competitive pressures” [RBI 2006].

Significant State Ownership

In terms of ownership patterns the state still holds not less than 51 per cent shares in all the nationalised banks. It is in the process of diversification of ownership of public sector banks (PSBs) where private ownership has increased in the range of 40-49 per cent in 11 PSBs, 30-40 per cent in three PSBs and 20-30 per cent in another three PSBs. However, as of end-March 2006, there were still four PSBs in which government shareholding was more than 90 per cent.

With regard to dominance in business, notwithstanding the extended opening of the banking sector to private and foreign banks thus, enhancing competition, the PSBs still account for almost three-fourths of assets of the commercial banking system. Despite a decline from a 79.5 per cent share in total assets of commercial banks in 2000-01, PSBs still maintain a

72.3 per cent share as of end March, 2006. Similarly their share in deposits is 75 per cent, in advances 72.9 per cent and in investments 73.1 per cent.

With the continuing dominance of PSBs both in terms of business as well as ownership, the banking system has become stronger during the last five years. “Capital and asset quality which are two crucial parameters reflecting the soundness of a financial institution, have improved steadily over the years” [RBI 2006]. Capital adequacy: The overall capital to risk weighted assets ratio (CRAR) for all the scheduled commercial banks (SCBs) was 12.4 per cent in end-March, 2006. This is significantly more than the stipulated minimum of 9 per cent. The ratio was

12.2 per cent for PSBs (Table 1 ). Two aspects deserve special mention. First, of the total capital of SCBs tier I (9.3 per cent) capital is three times the tier II (3.1 per cent) leaving more headroom for augmentation of capital through the tier II route. Second, in order to facilitate raising of capital for a smooth transition to Basel II, banks are now allowed to augment their capital funds by issue of innovative and hybrid instruments since January 2006. Asset quality: The most significant improvement indicating enhanced soundness of the Indian banking system has been a

Table 1: Soundness Indicators of Select Bank Groups: 2001 and 2006 (End March)

(Per cent)

2001 2006

Capital Adequacy: CRAR
(capital to risk weighted
asset ratio)
All scheduled commercial
banks (SCBs) 11.4 12.3
P S B s 11.2 12.2
Nationalised banks 10.2 12.3
New private sector banks
(NPSBs) 11.5 12.6
Non-performing assets
(NPAs): NNPA (net NPA
to net advances ratio)
S C B s 6.20 1.20
P S B s 6.70 1.30
Nationalised Banks 7.01 1.16
NPSBs 3.10 0.80
Gross NPAs (Gross NPA
to gross advances ratio)
S C B s 11.40 3.30
P S B s 12.40 3.70
Nationalised banks 12.16 3.96
NPSBs 5.10 1.70
Operational efficiency
(operating expenses to
assets ratio)
S C B s 2.64 2.11
P S B s 2.72 2.06
Nationalised banks 2.76 2.02
NPSBs 1.75 2.00

Source: Trend and Progress in Indian Banking 2005-06, RBI (2006).

Economic and Political Weekly December 9, 2006 sharp fall in the ratio of non-performing assets to total advances. The gross NPA to gross advances ratio for SCBs touched an all time low at 3.3 per cent in end-March 2006, a fall from 11.4 per cent in end-March 2001. For PSBs, the ratio reduced to 3.7 per cent from 12.4 per cent during the same period. The net NPA to net advances ratio for SCBs also touched a low of only 1.2 per cent in end-March 2006 compared to 6.2 per cent in end-March 2001. For PSBs it declined to 1.3 per cent from 6.7 per cent during the same period (Table 1). This shows the improvement of bank assets in India [RBI 2006].

A few other facts should also be taken into consideration. First, NPAs of the Indian banking system are now comparable to those of several advanced economies and are significantly lower than several economies in Asia. Second, the fall in the NPA ratio is the result of recoveries outpacing fresh accruals. The gross NPAs of SCBs declined by Rs 7,309 crore during 2005-06 over and above the decline of Rs 6,561 crore in the previous year. Third, a significant decline in gross and net NPAs is evident across all bank groups including PSBs. As of end-March 2006, as many as 66 banks out of 84 banks had a net NPAs to net advances ratio of less than 2 per cent. In the case of PSBs, 23 out of the 28 banks had a less than 2 per cent NPA ratio compared to only one bank out of the 27 banks in end-March 2001. Finally, the net non-performing loans to capital ratio, a worst case scenario measure is now down to 15.5 per cent compared to 71 .3 per cent in end-March 1999. Efficiency: Efficiency of the Indian banking system as reflected by the ratio of operating expenses to total assets has been consistently improving, particularly for the PSBs. The intermediation cost of PSBs has declined from 2.99 per cent in 1996 (end March) to 2.72 per cent in 2001 and further to 2.06 per cent in 2006 (Table 1).

Table 2: Groupwise Bank ProfitEfficiency (Median) of Indian Banks,1997-2003

Year SBI and Nation-Indian Foreign Its alised Private Banks Associates Banks Banks

1997 0.665 0.343 0.363 0.596 1998 0.835 0.316 0.514 0.677 1999 0.628 0.355 0.382 0.588 2000 0.680 0.510 0.488 0.650 2001 0.667 0.384 0.423 0.773 2002 0.715 0.513 0.541 0.620 2003 0.982 0.698 0.582 0.603

Source: Das et al (2005).

Measuring various efficiency scores of Indian banks through data envelopment analysis and nonparametric methodology Das et al (2005) found that over the period from 1997 to 2003, nationalised banks have been able to improve their profit efficiency scores considerably (Table 2). The study concludes that “on the basis of measured efficiency scores it may be difficult to claim that privatisation per se leads to greater efficiency, but at the same time it is also to be emphasised that greater managerial freedom enjoyed by a state owned bank that is listed in the stock market does help in boosting efficiency”.

With regard to efficiency of customer services, however, it may be difficult to defend a case for PSBs when compared to private or foreign banks, particularly when anecdotal evidence is cited. But there is no denying the fact that definitive trends in improved customer service efficiency are visible on the whole. Also, the Report provides a list of measures already initiated to improve efficiency in service for individual customers. Setting up of an independent body, the Banking Codes and Standards Board of India (BCSBI) to evaluate, oversee and enforce observance of the “code of bank’s commitment to customers” drawn by each bank, through the means of a “covenant” between each member bank and the BCSBI, is one such important step recently taken up by the RBI. The single most significant feature of the “code” is that now the common man will have a charter of rights in his hand, which he can enforce against his bank. Access to credit: It is rather surprising if not amusing to find that the World Bank policy research report (2001) concludes that “state ownership of banking leads to less access to credit outside the largest firms”. The Indian banking system has challenged all such conclusions. Disbursements by PSBs under special agricultural credit plans during the last three years have grown by 24.4. per cent in 2003-04, 54.5 per cent in 2004-05 and 44.6 per cent in 2005-06. As of end-March 2006, the cumulative number of self-help groups (SHGs) linked to banks stood at

2.2 million, with total bank credit to these SHGs at Rs 11,398 crore. Under the kisan credit card (KCC) scheme which was termed as a “technological innovation in providing credit to the agriculture sector in India, including small farmers”, by WDR 2005 (p 120), PSBs have issued 21.8 million KCCs. Finally, the RBI in its recent policy stance has focused mainly on financial inclusion which implies wider access to customers belonging to the poor sections of the society and the facility of a “no-frills” account either with “nil” or very low minimum balances.

Even after such significant improvements in capital adequacy, sharp reduction in NPA ratios and significant increase in profitability efficiency particularly for PSBs, if it is maintained that “India’s banking system is clearly fragile” or that the banking system is under “considerable distress” [Basu 2005], then it may only be a deliberate attempt not to recognise facts and having blind faith in privatisation. Admittedly, these conclusions may have been based on facts and beliefs at a time when this Report was unavailable; it is time now for critics of the Indian banking system to review and revise their views, or else start believing in the mythology of banking ownership.

Finally, the conclusion drawn in the World Bank studies that “maintaining the status with a significant share of state-run banks can be dangerous for the economy” has been absolutely disproved by recent trends in the Indian economy. Maintaining the dominant state ownership of banks, the Indian economy has been one of the fastest growing economies amongst the emerging market economies and its banking sector efficiency and productivity have increased significantly. To the extent that it is argued that all these improvements are owed to the dilution of ownership of PSBs, it may well be true that the reform measures excluding privatisation are highly successful.




Basu, Priya (ed) (2005): India’s Financial Sector,

Recent Reforms, Future Challenges,

Macmillan. Das, Abhiman, Ashok Nag, Subhash C Ray (2005):

‘Liberalisation, Ownership and Efficiency in

Indian Banking: A Nonparametric Analysis’,

Economic and Political Weekly, March 19. Reserve Bank of India (2006): Trend and Progress

of Banking in India, 2005-06, Reserve Bank

of India, Mumbai. World Bank (2001): ‘Finance for Growth, Policy

Changes in a Volatile World’, Policy Research

Report, World Bank, Washington DC.

  • (2002): World Development Report, 2002: Building Institutions for Markets, OUP, New York.
  • (2005): World Development Report, 2005: A Better Investment Climate for Everyone, World Bank, Washington DC.
  • Economic and Political Weekly December 9, 2006

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