A secure, efficient banking model for Global South
India’s mix of State-owned and private banks, reforms in the financial sector, the technology stack and credit bureaus can offer a more efficient template
As the adage goes, “It never rains, it pours.” The world is already reeling from inflation and rising interest rates, the war in Ukraine pushing up grain and energy prices, and superpower rivalry disrupting established supply chains. Then there are growing concerns among the intelligentsia on the use of generative Artificial Intelligence (AI); Covid fears that had abated across most parts of the world are again showing weak but worrying signs of revival; the labour markets that were red hot have turned to layoffs; and there is growing uncertainty that’s making chief executives put investment plans on hold.
Just when one thought that this was bad enough, there was a run on Silicon Valley Bank, a mid-sized American regional bank, after its CEO talked carelessly about the bank’s liquidity problems due to asset liability mismatches. The comment led to $40 billion being electronically withdrawn in two hours leading to the bank’s collapse. The bank’s deposits and advances were acquired by First Citizen’s bank, thereafter Signature bank failed, to stem the ensuing panic, Central banks provided assurance that uninsured deposits would be honoured and yet First Republic Bank looks feeble. In Europe, the venerable Credit Suisse needed to be merged with UBS to prevent its collapse. Thankfully there were no tremors in the Indian banking system, and therein lies a story.
Given that banks are institutions of intermediation, lending the deposits they receive, a run on the deposits of any bank will almost always bring it down. As a result, banks — and especially systemically important institutions — are subject to supervisory oversight, and deposits of small depositors are insured to give them the confidence to keep their money in banks. Large depositors are expected to be informed enough to go to the right banks. This also keeps bank management honest in the risks they take on to generate returns with depositor money and prevents moral hazard (the preferred term of economists). However, every 10 years or so, we see bank failures and there is a growing belief that banks always get bailed out. Given this, what would be the best banking model for the global South? I believe India could offer clues, especially in its G20 presidency year.
Between 1969 and 1992, about 90% of Indian banking was government owned. So, the risk of bank failures was with the taxpayers, not depositors. Bad loans by banks would lower the velocity of credit and bring down the efficiency and growth impulses of the economy, but not threaten depositors. The reforms of 1992 in India introduced big changes, and though India resisted the privatisation of public sector banks, competition in the sector was increased to improve efficiency. Prices (interest rates) were decontrolled, new private banks were given licences and public sector banks were encouraged to list to face market pressure. At the same time, India adopted the Basel framework of risk assessment, and scrutiny of bank asset portfolios was sharpened, ending an era of populist loan melas. The efficiency of the overall sector improved dramatically, bank balance sheets grew with the economy while their workforce shrank, and there was widespread adoption of technology.
However, public sector banks still suffered from the pathologies of government ownership — poor governance, lack of human resource autonomy, and decision impeding oversight from a vigilance angle. The failed infrastructure experiment in the 11th five-year plan (2007), where public sector bank balance sheets were used to fund infrastructure through public-private partnerships (PPP), brought about another banking crisis. Public sector banks fell prey to government persuasion to lend for capital projects that got stuck due to a mixture of policy volatility, PPP inflexibility, poor lending practices, a changed global economy and very unimaginative Reserve Bank of India (RBI) supervision, pushing Indian banking into a prolonged crisis. What is noteworthy is that government ownership ensured that there were no bank runs despite the high level of asset stress.
Despite large-scale government bank ownership, the efficiency of the Indian financial sector improved markedly in the last decade. Financial reforms have been path-breaking. Our technology stack, especially in financial services, is the benchmark for the world. The trinity of Jan Dhan Accounts, Aadhaar identifier, ubiquitous mobile phones, together with UPI-based retail payments, have made India the lowest transactions cost country on payments and fintech innovations are constantly challenging incumbent banks, and forcing them to catch up.
Indians are the largest consumers of data, using more data than the United States and China combined. Our credit bureaus are global benchmarks and have led to commoditising retail lending, with no variation in retail bad loans across banks. Public sector banks have been consolidated — all State Bank of India subsidiaries have been merged into the parent, 13 public sector banks have been consolidated into five large banks, and only seven remain independent.
The Global South needs a banking system that provides both security and efficiency. It does not need exotic financial innovation that essentially creates value for the bank itself - bank managements and shareholders – and socialises losses to taxpayers. So, though India’s regulatory regime needs urgent cleaning up (a discussion for another time) its banking structure has the seeds of a banking model for the South. I have argued for nearly two decades that the government should privatise the remaining seven public sector banks but continue to be a majority owner of SBI and become the single largest “non-majority owner” of the other five nationalised banks by bringing its stake down to 26% and unlocking value for the government. This structure will provide depositor security, strong but not unbridled competition, fintech-led innovation, operational autonomy to government-led banks and a stable banking system. It will be more “utility than fintech” but will provide consistent and safe returns and not be prone to booms and busts. This could unapologetically be the model for the South.
Janmejaya Sinha is India chairman, Boston Consulting Group
The views expressed are personal
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