The bank’s a private matter

Questions about privatisation of Indian banking can be asked in two ways. One way of asking the question is: are PSU banks being privatised? The answer is clearly no. Not only are they not being privatised, the privatisation of PSU banks is not on the government’s agenda. The second way of asking the question is: is the share of private banks in Indian banking increasing? Let us look at the evidence. When, in 1993, the entry of ‘‘private banks’’ began, in competition with PSU banks, it was expected that they would rapidly gain market share.

Yet, despite all the inefficiency, PSU banks have apparently not been falling much behind their slick private cousins. This is starkly visible in their share of bank deposits. In 1997, this share was 84 per cent. By 2003, it had fallen to 79 per cent. Over a six-year period, a drop of hardly 5 per cent is certainly not dramatic.

This experience in banking is in sharp contrast with the mutual fund and telecom industries, where the onset of private and foreign competition led to very rapid loss of market share of the PSUs. India effectively has a modern, competitive industries in telecom mutual funds, without the overhang of inefficient PSUs. But this has not happened in banking. Does this mean that PSU banks are better than PSU phone companies?

The devil lies in the details. Bank deposits are made up of fixed deposits and ‘‘demand deposits’’ (where customers get cheque books, such as current accounts or savings accounts). The strength of deposits with public sector banks has been mainly in fixed deposits. This is where savings get parked for an extended period, and the fact that the government is the owner of the bank matters most as it makes deposits in it safe. It is also where the component of service provision is small. This is where the Government is giving a major subsidy to PSU banks — a sovereign guarantee — which is not being given to private banks. Such a competitive handicap was not found in the telecom sector, where PSUs lost market share. The growth of fixed deposits of PSU banks has been relatively high, an average annual growth rate of 16.5 over 1994 to 2003.

Where PSU banks seems to be losing out very fast is in demand deposits. These are mainly current deposits. In this area, the quality of customer service matters much more than in fixed deposits. Private and foreign banks have excelled at delivering good services using ATMs, call centres, the Internet, and a non-unionised labour force. The rate of growth of demand deposits in PSUs was still an average annual growth of 15 per cent in the period 1994-2000, but since then has declined to a mere 6.7 per cent per annum. In contrast, the growth of non-PSU banks has accelerated from 25 per cent to 43 per cent, raising their market share to 30 per cent in 2004. Another clear area where private banks are winning is in fee-based servcies. The difference between the experience of getting a draft made in a PSU and in a private bank is stark. Moreover, the role of the sovereign guarantee providing an aura of comfort is irrelevant. Not surpringly, it is private banks that have bagged most of the increase in services in the last few years. Growth of revenue from fee-based services has slipped sharply in PSU banks. Private banks have been obtaining a much higher growth of 30 per cent.

In the last ten years fee-based services of PSU banks have been increasing at a rate of 11 per cent, while that of non-PSUs has increased at 22 per cent. Recently, PSU fee-based revenue is growing at 5 per cent per annum. As a consequence, the market share of PSUs in these services has fallen sharply from 80 per cent in 1996 to 66 per cent this year. The share of private Indian banks has increased from less than 5 per cent to 19 per cent.

Similar trends are observed in growth rates of loans and advances. In the period 1994-2000 loans and advances by PSUs were growing faster at 20 percent than by non-PSUs at 14 per cent. In 2000 to 2004, the situation has reversed. PSU lending business is growing at 30 per cent, lower than non-PSU lending business at 48 per cent. As a consequence the market share of non-PSU’s is rising much faster and reached 27 per cent in 2004. If we break up banking into fixed deposits, demand deposits, loans and advances and fee-based services, the subsidy of the sovereign guarantee is powerfully in favour of PSU banks in fixed deposits, and this is where they have done relatively well. PSU banks have done badly in the other areas, where competence matters, and a comparable subsidy from the government is not present.

Treasury profits have been very significant in the last 2-3 years. The upward movement in interest rates is likely to eliminate this sources of profit for most banks. Fee-based services and demand deposits will be disproportionaly important for profitability. The faster decay of PSU market share in these areas may hence presage a decline in the profitability of PSU banking. Looking forward, we are likely to see an accelerating drop in PSU market share in fee-based services and in demand deposits in 2004-05 and 2005-06. This would have sharply adverse consequences for the profitability of PSU banking.

In the last few years, private and foreign banks were still in the process of putting their technology and processes into place. They now have highly scalable organisations and can grow rapidly. Hence, the loss of PSU market share on the issue of customer service in the next few years may be stronger than was observed in the past. One way to privatise an industry is to sell off public sector units. India has not addressed the problem of PSU banking in this fashion. The other way is to allow entry of private firms into the industry and hope that the forces of competition will reduce the market share of the public sector. While privatisation of nationalised banks is not happening in India, slowly but surely the banking sector is becoming private and modern, through the loss of PSU market share.

Ila Patnaik