This has implications for the financial sector as the government owns LIC, and LIC not just owns Industrial Development Bank of India (IDBI) but also has stakes in several other financial organisations (Ramesh Pathania/Mint)
This has implications for the financial sector as the government owns LIC, and LIC not just owns Industrial Development Bank of India (IDBI) but also has stakes in several other financial organisations (Ramesh Pathania/Mint)

The world of Indian finance and banking is set for a major overhaul

Apart from privatising banks and establishing what appears to be akin to a bad bank, the government has also decided to privatise a general insurance company and make legislative changes for the listing of Life Insurance Corporation
By Amol Agrawal
PUBLISHED ON FEB 16, 2021 08:17 PM IST

In the Union Budget, finance minister (FM) Nirmala Sitharaman announced several policies for the financial sector, including, most notably, the privatisation of two of the 12 public sector banks (PSBs). New reports suggest that Bank of Maharashtra, Bank of India, Indian Overseas Bank and the Central Bank of India have been shortlisted with this objective. This is welcome as PSBs have, for long, been bleeding the Indian exchequer, symbolised in yet another recapitalisation of 20,000 crore in the same budget. PSBs have also created problems of dual regulation as highlighted by former RBI officials, Urjit Patel and Viral Acharya, in their respective books.

The markets will keenly watch which two are finally chosen and, more importantly, who gets control of these banks. The Indian banking sector is getting concentrated with limited players.

Whether the two banks go to existing players or new ones has to be seen in the context of recent controversies around whether Indian corporates should be allowed to own banks. The Deposit Insurance and Credit Guarantee Corporation Act, 1961, will also be amended, which will enable depositors to get their savings up to 5 lakh when the bank is under moratorium. Another important step is to set up an Asset Reconstruction Company Limited and Asset Management Company, which will buy the stressed assets of PSBs and sell it to other investors.

Apart from privatising banks and establishing what appears to be akin to a bad bank, the government has also decided to privatise a general insurance company and make legislative changes for the listing of Life Insurance Corporation (LIC). This has implications for the financial sector as the government owns LIC, and LIC not just owns Industrial Development Bank of India (IDBI) but also has stakes in several other financial organisations. There is also a proposal to increase foreign direct investment in insurance from 49% to 74%.

These decisions are monumental as they reverse a long history of nationalisation of the financial sector. LIC was nationalised in 1956, banks were nationalised in 1969 (and 1980) and general insurance companies were nationalised in 1972.

As we move forward with reprivatising banks and insurance, the idea of starting a new Development Financial Institution (DFI) also takes us back to the 1960s. We already have several existing DFIs and most are either struggling or have got converted to banks as their business model was no longer viable. Unless this new DFI has better governance structures and clear targets avoiding turf wars with existing DFIs, a repeat cannot be ruled out as is also seen from the initial reports.

A better idea to finance infrastructure is to develop the corporate bond market, which Indian capital markets have long been waiting for. The government has proposed setting up a body which will “purchase investment grade debt securities both in stressed and normal times and help in the development of the bond market”. This will be like the primary dealer system established in the 1990s to build activity in government bond markets.

RBI’s policy created news in a totally unexpected domain. It has now allowed retail investors to open a securities account with itself to buy and sell government securities. For long, authorities have tried to open government bond markets to retail investors. This benefits the government as it broadens the investor base and gives retail investors more investment options.

As financial intermediaries have struggled to deepen this retail market, RBI has decided to take matters into its own hands. But even if this is not the intent, the move does put RBI in competition with banks and mutual funds for retail savings. In case of a crisis in any bank, depositors now have the incentive to shift their funds not just between banks but also to RBI. Apart from this structural reform, RBI has also announced that it is studying whether India needs a Central Bank Digital Currency.

Put it all together and it is clear that the world of Indian finance is set for major changes.

Amol Agrawal is a faculty member at Ahmedabad University. He writes the Mostly Economics blog

The views expressed are personal

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