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Resource centre on India's rural distress
 
 

Public sector banks have ensured financial inclusion, finds a new empirical study

Are public sector banks (PSBs) important for the economy? Have the PSBs served the purpose for which they were created? Could the PSBs compete efficiently against the private sector banks (PVBs)? These are some of the questions, which have been answered by a chapter in the RBI Bulletin's August edition.

Efficiency of PSBs

Co-authored by Snehal S Herwadkar, Sonali Goel, and Rishuka Bansal (2022) of the Banking Research Division, Reserve Bank of India (RBI), their write-up 'Privatisation of Public Sector Banks: An Alternate Perspective' shows that institutions like PSBs are created to address market failures, and often their social benefits outweigh the social costs. Using the data envelopment analysis (DEA) framework, a linear-programming-based method, to assess the efficiency levels of various types of banks in India over the period from 2010 to 2022, the authors detect that the efficiency of the PVBs has always surpassed that of the PSBs when it comes to attaining the objective of just profit maximisation. However, when the objective function is altered to accommodate the socially desired goal of financial inclusion — like total branches, agricultural advances and priority sector lending (PSL) advances — PSBs turn out to be more efficient than the PVBs.

Contradicting the usually repeated allegation that the PSBs are inefficient as compared to the PVBs, Herwadkar, Goel and Bansal (2022) show that while incurring lower labour cost, PSBs can generate a higher level of output vis-à-vis the PVBs. A higher labour cost efficiency by the PSBs could be attained on account of the effective use of banking business correspondent (BC) model, coupled with implementation of other cost-efficient techniques. 

Role of PSBs in financial inclusion

In their empirical endeavour, Herwadkar, Goel and Bansal (2022) reveal that the majority of the credit needs in the rural areas is met via the PSBs. In rural areas, PSBs' share of bank branches is greater than that of PVBs. Likewise, PSBs' share in ATMs in rural areas is more than twice that of the PVBs. In rural areas, PSBs' share in BC outlets has stayed consistently above 60 percent over the years, the highest among the bank groups. The study conveys that financial services have been made available in rural and financially excluded areas by the PSBs through the use of business correspondent (BC) model. On the contrary, the PVBs have deployed the BC model mainly in urban areas.

The main objective of the Pradhan Mantri Jan Dhan Yojana (PMJDY) is to ensure universal access to banking facilities with at least one basic banking account for every household. As of July 2022, over 45 crore beneficiaries have been connected to banks and 78 percent of these accounts were opened in the PSBs. On top of that, over 60 percent of PMJDY accounts opened in PSBs were located in rural and semi-urban areas. 

Granular analysis of data by the 3 co-authors indicate that the priority sector targets have not been met by the PVBs through organic lending but through investment in priority sector lending certificates (PSLCs), especially in agriculture and small and marginal farmers categories. 

People's trust in PSBs
  
Depositors tend to transfer their money from banks with weaker financial health, which includes not just small private banks alone (like Yes Bank and Lakshmi Vilas Bank) but also some PSBs, to stronger banks, which can be either public or private. Stronger PSBs have helped in protecting market confidence during times of economic distress. Due to the trust in PSBs, they have been able to raise higher resources in comparison to that by their private counterparts. 

Countercyclical role played by the PSBs

PSBs have not only provided credit to the farm sector, it has extended massive loans to the industrial and corporate sector as well, even during the cyclical downturn that began in the Indian economy from 2017-18 onwards. The corporate bond markets in India are not deep and vibrant. Although the larger and stronger industries can raise resources via the equity market route, the smaller entities, such as the micro, small and medium enterprises (MSMEs) are unable to raise capital through that route. Thus, the PSBs have played an important role in financing industrialisation and helping enterprises of various size and scale. 

If seen against the backdrop of withering away of erstwhile development financial institutions, then one can say that the PSBs have played an important role in providing infrastructure finance.

Evidence shows that the PSBs are more effective in monetary policy transmission, thus aiding the countercyclical monetary policy actions of the Government to gain traction, point out the three researchers in their write-up. During the last easing cycle (i.e., from February 2019 to March 2022), the reduction in lending rates of PSBs was substantially higher than that of PVBs. 

By using the econometric technique of fixed effect panel regression (on quarterly data for 30 banks during the period from March 2005 to March 2022), Herwadkar, Goel and Bansal (2022) arrive at the results to state that PVB lending is more procyclical as compared to that of PSBs.

Recommendations

In order to clean up the legacy burden of bad loans from the balance sheets of PSBs, an entity called National Asset Reconstruction Company Limited (NARCL) has been created. Instead of large scale privatisation of the PSBs in one go, a gradual approach by the Union Government will help to avoid creating a void in the arena of banking to achieve the social objectives of financial inclusion and monetary transmission, suggest the RBI researchers.  

 

References

Privatisation of Public Sector Banks: An Alternate Perspective, in RBI Bulletin August 2022, Volume LXXVI, Number 8, please click here and here to access

RBI clarifies on recent bulletin article on privatisation of public sector banks, Livemint.com, 19 August, 2022, please click here to access

RBI Bulletin: A big bang approach to PSB privatisation may do more harm than good, Moneycontrol.com, 18 August, 2022, please click here to access

 

Image: Inclusive Media for Change/ Shambhu Ghatak