Context: Recently, the government announced the privatization of two public sector banks. 

• The decision is going to change the banking landscape in India after 51 years of nationalisation of government-owned banks in 1969. 
• The two banks will be selected through a process in which NITI Aayog will make recommendations, which will be considered by a core group of secretaries on disinvestment and then the Alternative Mechanism (or Group of Ministers).
• Presently, India has 22 private banks and 10 small finance banks.

Background

• State Bank of India (SBI): SBI had been nationalised in 1955 and the insurance sector in 1956.
• Nationalisation of the 14 largest private banks in 1969: The idea was to align the banking sector with the socialistic approach of the government. 
• Various governments since then were for and against privatisation of PSU banks. 
• The government has already privatised IDBI Bank by selling its majority stake in the lender to LIC in 2019 and merged 14 public sector banks in the last four years.
• Various announcements made in the budget of the central government regarding reform measures like privatisation of IDBI Bank and two PSBs, setting up of bad bank, disinvestment in LIC, privatisation of one general insurance company, allowing FDI in insurance sector up to 74 per cent, aggressive disinvestment and sale of public sector undertakings, etc

Committee recommendations: Many committees had proposed bringing down the government stake in public banks below 51% - the Narasimham Committee proposed 33% and the P J Nayak Committee suggested below 50%. 

• An RBI Working Group recently suggested the entry of business houses into the banking sector. 
• The NDA government in its second term: Has been pushing for privatisation and reducing the number of PSU banks to five or six.

Steps taken before proposing for privatisation

• Recapitalisation: The government front-loaded Rs 80,000 crore in FY18 and Rs 1.06 lakh crore in FY19 through recapitalisation bonds into government-run banks. 
• Merging: In 2019, the government merged ten PSU banks into four.

About Public Sector Banks

• Currently, there are ten nationalised banks in addition to IDBI Bank and SBI.
• PSU banks are under dual control, with the RBI supervising the banking operations and the Finance Ministry handling ownership issues.

The Budget announcements

• The privatisation of two public sector banks, in addition to IDBI Bank and one general insurance company in the upcoming fiscal. 
• A strategic sale or disinvestment policy for four strategic sectors, including - banking, insurance and financial services, in which it will have a bare minimum presence.

Need for privatisation

Poor financial position: After years of capital injections and governance reforms, the financial position of public sector banks (PSBs) have not improved significantly. 

• Many of the PSBs have higher levels of stressed assets than private banks.
• Their performance is also poor in terms of profitability, market capitalisation and dividend payment record. 

High Non Performing Assets (NPAs): As per the RBI’s recent Financial Stability Report, gross NPA ratio of all commercial banks may increase from 9.7% to 16.2% for public sector banks and from 4.6% to 7.9% for private banks.

• After the Covid-related regulatory relaxations are lifted, banks are expected to report higher NPAs and loan losses. 

Private banks doing better

• The RBI has allowed more private banks since the 1990s. 
• India has 22 private banks and 10 small finance banks.
• They have expanded the market share through new products, technology, and better services. 
• Private bank’s market share in loans has risen to 36% in 2020 from 21.26% in 2015, while public sector banks’ share has fallen to 59.8% from 74.28%. 

Significance

• Consolidation: Privatisation of two public sector banks will enable a long-term project that envisages only a handful of state-owned banks, with the rest either consolidated with strong banks or privatised. 
• Free up the government (the majority owner): From continuing to provide equity support to the banks year after year.  Through a series of moves over the last few years, the government is now left with 12 state-owned banks, from 28 earlier.
• Private players will emerge as a key player: The move will also give the private sector a key role in the banking sector.

Concerns

• Seems to be a political decision: The privatisation of two banks and the indication of carrying it further is a major reform signalling a changing political approach. 
• Finding market led solutions: The privatisation move along with setting up an asset reconstruction company entirely owned by banks, underline an approach of finding market-led solutions to challenges in the financial sector.
• Questions have arisen over the performance of private banks: Especially the governance issues. For example, Recently ICICI Bank MD and CEO was sacked for allegedly extending dubious loans. 
• Also, many private sector banks were found under-reporting NPA.

Repeating the mistakes of the 1960s: Back then the private sector was not sufficiently aware of its larger social responsibilities and was more concerned with profit.

• Only after assessing the success of the privatisation of the first two banks, the government should go for divestment in other banks in the coming times.