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Trilemma In Policy Towards PSB’s
Former RBI governor, Urijit Patel has pointed out a trilemma faced by the government and RBI in policy towards PSB’s(Public sector banks). Due to this trilemma, it is proposed that privatization of the banking sector must not be prevented.
What is this trilemma?
Policies towards PSB’s cannot achieve following 3 outcomes at the same time:
- Have predominant public sector in banking system
- Have independent regulation by RBI
- Adhering to public debt to GDP ratio targets
Only any 2 of the 3 outcomes can be achieved.
- Predominant public sector and independent regulation by RBI:
- For predominant public sector, PSB’s will have to lend more. This will increase NPAs(Non performing assets) with PSB’s.
- Due to independent regulation of RBI, these loans will have to be declared stressed and banks must provide adequate provisions to cover bad loans. This provisioning of bad loans will lead to reduced capital with banks.
- To maintain capital adequacy ratio(CAR) of PSB’s, the government has to infuse liquidity into them. This raises public debt to GDP ratio
- Predominant public sector and adherence to debt to GDP targets:
- Predominant public sector leads to higher NPAs in PSBs as seen above.
- For the government to maintain debt to GDP ratio target, it cannot provide much liquidity infusion into PSB’s. Hence to maintain a healthy CAR of banks despite rising NPAs, such NPA’s must not be recognized.
- This occurs only when RBI dilutes NPA recognition regulations. Hence RBI’s autonomy is compromised.
- This pushes the NPA problem into the future where bad loans pile up and become a financial sector crisis. Hence it is undesirable. India’s NPA crisis in 2015-2019 is due to such practices post global financial crisis.
- Independent regulation by RBI and Adherence to debt to GDP ratio targets: Here PSB’s cannot play a dominant role. Hence even when bad loans with the private sector rises dut to stringent regulation by RBI, the government need not provide capital infusion to private players. This checks any rise of debt to GDP ratio.
Considering this it is proposed that privatization of the banking sector should not be prevented. Fall of PSB share in lending from 75% to 57.5% in the last decade shows that such privatization is happening gradually.
Counterpoint to the trilemma:
Recent case of Yes bank shows that the government will still need to intervene in case of private bank failures to save the interests of depositors. In such cases, the underlying assumption in the trilemma that without predominant PSB’s, the government need not infuse capital, is not justified.
This was seen even after the global financial crisis of 2008 and banking sector meltdown in advanced economies. There were huge bailouts by governments to private banks.
While India does face this trilemma as proposed by the former governor, unchecked privatization may not be the solution. A balanced approach is needed where the resolution process of financial failure of private banks needs to be evolved. These norms must address how to secure depositor interests.
- Privatization of PSB’s is the need of the day to improve efficiencies and to reduce government expenditure. Critically discuss? [15 marks, 250 words]