Nationalized banks in India are being sought to be privatized on the basis of an argument, originally advanced by P. Chidambaram and more recently by Arun Jaitley, that without it India cannot meet the Basel III "norms". The argument goes as follows.
The Basel III agreement has set " norms" with regard inter alia to the size of the equity base that banks in all the signatory countries must meet, for ensuring their sound financial health; fulfilling these " norms" requires an increase in the size of the equity base of the nationalized banks in India, for which the government does not have the budgetary resources; hence it must tap private capital by reducing the share of government equity and increasing that of private equity.
Neither of the two finance ministers, to be sure, has yet argued for reducing the government to a minority share- holder in nationalized banks, so that calling such equity dilution " privatization" may be objected to by some; but one cannot pretend that with the private equity share at 49 per cent, the nationalized banks can ignore private attempts to influence their behaviour.
Even if the ownership of this 49 per cent is widely dispersed, it still makes nationalized banks vulnerable to private pressures. Such dilution in short does amount to de facto privatization. The ministers' argument, however, is a completely spurious one.
Whether India should be following Basel III "norms" at all is itself a debatable point. Bank nationalization in India was meant to serve a social purpose: to reach bank credit to peasants, petty producers and small capitalists who had been excluded from it earlier, and it is precisely because of this widening of the reach of bank credit that the country could break out of the stagnation that foodgrain production had entered into by the mid- 1960s (even if the abysmal output levels of 1965- 66 and 1966- 67 which produced the Bihar famine are ignored).
This purpose is at loggerheads with the Basel III "norms", which, if strictly adhered to, would exclude many of these borrowers, even though lending to them is safer than to the big capitalists who use it for speculative purposes, that is, for participating in stock market or property market "bubbles". This fact, resoundingly demonstrated by the 2008 financial crisis, when, ironically, the nationalized banks in India were lauded for not having got into "toxic" assets as private banks all over the world had done, is hardly likely to be appreciated by a meeting of conventional bankers in Basel who prescribe such "norms". It follows that a government committed to social banking cannot be bound by Basel III "norms". The fact that the government wants even the nationalized banks to follow these " norms" is because it has opened the economy to the vortex of globalized financial flows; and when that happens, you cannot ignore the demands of the Basel financial elite, even if they go against your social purpose . But let us leave aside this point, and assume that Basel III "norms" with regard to the equity of the nationalized banks have simply got to be met. Even so, the argument of the finance ministers is a spurious one, because it assumes that the government needs to pay for the additional equity of the nationalized banks from budgetary sources; there is absolutely no reason why it should do so.
Whatever the additional amount that needs to be provided by the government for meeting the enhanced equity base required by the Basel III "norms" can simply be borrowed from the Reserve Bank of India.
Suppose for simplicity that Rs 100 has to be provided and that the government borrows this amount from the RBI and gives it to the banks as equity capital. If the banks in turn simply hold this amount with the RBI itself, then all that would have happened is a mere book transaction on the part of the RBI, with absolutely zero effects on the real economy . Technically, such borrowing from the RBI constitutes " deficit financing", but in this case, since no funds would get into the economy at all, there is no question of there being any effects whatsoever, let alone any harmful effects, of such " deficit financing" on the economy.
Of course, if the banks' equity base goes up by Rs 100 and they hold all of it in the form of cash with the RBI, then the banks' cash reserve ratio, which is the ratio of their cash- holding to total assets, would have increased (since both the total assets and the cash component of it would have increased by the same amount). But there is absolutely nothing that forbids banks from holding cash reserves in excess of what is statutorily required. There is no problem relating to interest payments either, since the entire arrangement is between the government, the nationalized banks, and the RBI (whose profits accrue to the government anyway).
In short, the provision of additional equity for nationalized banks is a complete non- issue. And the reason for its being a non- issue is simply that with nationalized banks, the government is committed to protecting them anyway, precisely by virtue of being their owner. No Basel III "norm" in terms of equity base is actually necessary for them, for they already enjoy the protection of the sovereign government that owns them. Fulfilling this equity "norm" which is unnecessary can therefore take the form of a mere book transaction, which is no more than just a ritual.
The government's borrowing from the RBI to increase the equity base of the nationalized banks will, on paper no doubt, raise the fiscal deficit, and hence contravene the Fiscal Responsibility and Budgetary Management Act that puts a ceiling on the fiscal deficit. But, as already suggested, it would have absolutely no effects on the economy.
To drag in the FRBM Act to thwart this obvious way of enhancing the equity base of the nationalized banks, through a mere book transaction, would therefore be sheer folly. It may be argued that even though we know that such a book transaction will not have any real economic effects, the foreign investors may get frightened if the fiscal deficit, because of this titular component, exceeds the provision of the FRBM Act. To this, however, one can only say, first, that the foreign investors are not so stupid as not to see the titular nature of this fiscal deficit; and, second, that if they still get put off by it, then one should not allow their stupidity or invidiousness, whichever way one interprets their intransigence, to alter a basic parameter of policy in the country, which is to promote social banking through the nationalized banks.
There is indeed an instructive precedent here. When the financial crisis hit the United States of America upon the collapse of the housing bubble, the Barack Obama administration had made a provision of $ 13 trillion for supporting the American financial system. The US does not have any equivalent of an FRBM Act; but, even so, nobody was concerned about this amount being set aside, because the administration was not being actually called upon to spend this amount. It was in the form of guarantees, or pledges of support, on the part of the administration, should the need arise, which is exactly what the Union government's enhanced equity support to banks would amount to, according to the conception I have put forward.
It follows that the entire argument about the need to privatize nationalized banks because of the paucity of fiscal resources to enhance their equity base is a totally spurious one, since no such fiscal resources are needed. But this is so obvious a point that one cannot imagine it’s not having struck the finance ministry mandarins. The fact that they still advance this argument, therefore, needs an explanation.
And the real explanation is that there has been immense pressure from international financial organizations and the US administration upon India for privatizing its public sector banks. Indeed several US treasury officials from Lawrence Summers to Timothy Geithner have met our finance ministry mandarins in New Delhi to persuade them to privatize at least the State Bank of India, if not the whole set of public sector banks.
And our mandarins, notwithstanding their own predilection in favour of such privatization, which arises from their own penchant for neo- liberal " reforms", have been held back by the immense political opposition it would generate within the country, including from within the ruling political formations.
Given this stalemate, passing off privatization, and that too of a " soft" kind that does not actually entail making the government a minority share- holder, as being absolutely necessary for " technical" reasons having to do with Basel III is a subterfuge resorted to by our mandarins. It is an utterly disingenuous exercise, which, for that very reason at least, must not be allowed to succeed.
The Basel III agreement has set " norms" with regard inter alia to the size of the equity base that banks in all the signatory countries must meet, for ensuring their sound financial health; fulfilling these " norms" requires an increase in the size of the equity base of the nationalized banks in India, for which the government does not have the budgetary resources; hence it must tap private capital by reducing the share of government equity and increasing that of private equity.
Neither of the two finance ministers, to be sure, has yet argued for reducing the government to a minority share- holder in nationalized banks, so that calling such equity dilution " privatization" may be objected to by some; but one cannot pretend that with the private equity share at 49 per cent, the nationalized banks can ignore private attempts to influence their behaviour.
Even if the ownership of this 49 per cent is widely dispersed, it still makes nationalized banks vulnerable to private pressures. Such dilution in short does amount to de facto privatization. The ministers' argument, however, is a completely spurious one.
Whether India should be following Basel III "norms" at all is itself a debatable point. Bank nationalization in India was meant to serve a social purpose: to reach bank credit to peasants, petty producers and small capitalists who had been excluded from it earlier, and it is precisely because of this widening of the reach of bank credit that the country could break out of the stagnation that foodgrain production had entered into by the mid- 1960s (even if the abysmal output levels of 1965- 66 and 1966- 67 which produced the Bihar famine are ignored).
This purpose is at loggerheads with the Basel III "norms", which, if strictly adhered to, would exclude many of these borrowers, even though lending to them is safer than to the big capitalists who use it for speculative purposes, that is, for participating in stock market or property market "bubbles". This fact, resoundingly demonstrated by the 2008 financial crisis, when, ironically, the nationalized banks in India were lauded for not having got into "toxic" assets as private banks all over the world had done, is hardly likely to be appreciated by a meeting of conventional bankers in Basel who prescribe such "norms". It follows that a government committed to social banking cannot be bound by Basel III "norms". The fact that the government wants even the nationalized banks to follow these " norms" is because it has opened the economy to the vortex of globalized financial flows; and when that happens, you cannot ignore the demands of the Basel financial elite, even if they go against your social purpose . But let us leave aside this point, and assume that Basel III "norms" with regard to the equity of the nationalized banks have simply got to be met. Even so, the argument of the finance ministers is a spurious one, because it assumes that the government needs to pay for the additional equity of the nationalized banks from budgetary sources; there is absolutely no reason why it should do so.
Whatever the additional amount that needs to be provided by the government for meeting the enhanced equity base required by the Basel III "norms" can simply be borrowed from the Reserve Bank of India.
Suppose for simplicity that Rs 100 has to be provided and that the government borrows this amount from the RBI and gives it to the banks as equity capital. If the banks in turn simply hold this amount with the RBI itself, then all that would have happened is a mere book transaction on the part of the RBI, with absolutely zero effects on the real economy . Technically, such borrowing from the RBI constitutes " deficit financing", but in this case, since no funds would get into the economy at all, there is no question of there being any effects whatsoever, let alone any harmful effects, of such " deficit financing" on the economy.
Of course, if the banks' equity base goes up by Rs 100 and they hold all of it in the form of cash with the RBI, then the banks' cash reserve ratio, which is the ratio of their cash- holding to total assets, would have increased (since both the total assets and the cash component of it would have increased by the same amount). But there is absolutely nothing that forbids banks from holding cash reserves in excess of what is statutorily required. There is no problem relating to interest payments either, since the entire arrangement is between the government, the nationalized banks, and the RBI (whose profits accrue to the government anyway).
In short, the provision of additional equity for nationalized banks is a complete non- issue. And the reason for its being a non- issue is simply that with nationalized banks, the government is committed to protecting them anyway, precisely by virtue of being their owner. No Basel III "norm" in terms of equity base is actually necessary for them, for they already enjoy the protection of the sovereign government that owns them. Fulfilling this equity "norm" which is unnecessary can therefore take the form of a mere book transaction, which is no more than just a ritual.
The government's borrowing from the RBI to increase the equity base of the nationalized banks will, on paper no doubt, raise the fiscal deficit, and hence contravene the Fiscal Responsibility and Budgetary Management Act that puts a ceiling on the fiscal deficit. But, as already suggested, it would have absolutely no effects on the economy.
To drag in the FRBM Act to thwart this obvious way of enhancing the equity base of the nationalized banks, through a mere book transaction, would therefore be sheer folly. It may be argued that even though we know that such a book transaction will not have any real economic effects, the foreign investors may get frightened if the fiscal deficit, because of this titular component, exceeds the provision of the FRBM Act. To this, however, one can only say, first, that the foreign investors are not so stupid as not to see the titular nature of this fiscal deficit; and, second, that if they still get put off by it, then one should not allow their stupidity or invidiousness, whichever way one interprets their intransigence, to alter a basic parameter of policy in the country, which is to promote social banking through the nationalized banks.
There is indeed an instructive precedent here. When the financial crisis hit the United States of America upon the collapse of the housing bubble, the Barack Obama administration had made a provision of $ 13 trillion for supporting the American financial system. The US does not have any equivalent of an FRBM Act; but, even so, nobody was concerned about this amount being set aside, because the administration was not being actually called upon to spend this amount. It was in the form of guarantees, or pledges of support, on the part of the administration, should the need arise, which is exactly what the Union government's enhanced equity support to banks would amount to, according to the conception I have put forward.
It follows that the entire argument about the need to privatize nationalized banks because of the paucity of fiscal resources to enhance their equity base is a totally spurious one, since no such fiscal resources are needed. But this is so obvious a point that one cannot imagine it’s not having struck the finance ministry mandarins. The fact that they still advance this argument, therefore, needs an explanation.
And the real explanation is that there has been immense pressure from international financial organizations and the US administration upon India for privatizing its public sector banks. Indeed several US treasury officials from Lawrence Summers to Timothy Geithner have met our finance ministry mandarins in New Delhi to persuade them to privatize at least the State Bank of India, if not the whole set of public sector banks.
And our mandarins, notwithstanding their own predilection in favour of such privatization, which arises from their own penchant for neo- liberal " reforms", have been held back by the immense political opposition it would generate within the country, including from within the ruling political formations.
Given this stalemate, passing off privatization, and that too of a " soft" kind that does not actually entail making the government a minority share- holder, as being absolutely necessary for " technical" reasons having to do with Basel III is a subterfuge resorted to by our mandarins. It is an utterly disingenuous exercise, which, for that very reason at least, must not be allowed to succeed.
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