Preferential Treatment of Public Sector Banks

Public Sector Banks (hereinafter referred to as PSBs) can be labelled as the backbone of any economy. That is to say, the health of an economy can be driven by PSBs. For example, considering the current scenario (facing the effect of Coronavirus), the Gross Domestic Product (hereinafter referred to as GDP) contraction of India has been the worst in over four decades, resulting in increased pressure on the government. Subject to the National Statistical Office, the GDP numbers have even turned negative for the fiscal year 2020-21. With the long-term goal of reviving the economy, the government aims to infuse more funds into the market in the form of recapitalization into the PSBs.

The PSBs are deemed to be performing well if they are paying interest on Fixed Deposit Receipt (hereinafter referred to as FDR) and other deposits, and at the same time if they can earn interest on loans and advances. The loans and advances can be catered only if they have sufficient funds at their disposal. Thus, once recapitalized is done, they can segregate the best businesses, shortlist the best industries, prioritize sector landing, or cater to any or every specialized need of the country. But then the question arises that why should only PSBs be recapitalized when there are other options also available in the form of non-financial companies.

To answer it in layman’s terms, PSB’s are preferred to non-financial companies because of the following reasons-

1. Nature of Funding- PSBs are multi-purpose funding as compared to non-financial companies which are catering to only specific purposes. For example, Manappuram Finance Limited provides loans against only gold, Housing Development Finance Corporation provides loans against only housing, and Shriram Transport Finance Company provides loans against only commercialized vehicle transport. These are all examples of non-financial companies. PSBs on the other hand have no such limitation. They can provide term loans, housing loans, plant and machinery loans, cc limits, etc. Thus, funding from PSBs is more liberal.

2. Geographical Presence- The non-financial companies are limited in their geographical presence, however, PSBs have a pan-India presence. This makes PSBs accessible even in remote areas.

3. Network- Because the non-financial companies have a limited geographical presence, their network is also limited as compared to PSBs.

4. Manpower- The manpower required to cater to the business requirements to fund easy credit is not readily available with non-financial companies viz a viz the PSBs. The lack of easy credit, in the context, lays out a lot of compliance norms that are required by non-financial companies in addition to the above-stated limitations.

5. Quantum of Loans- PSBs can have exposure to a very high quantum of loans in any or every industry depending upon the financials and net worth of the industry. The quantum of loans is however limited in non-financial companies because of their specific purpose object clause in the Memorandum of Association (hereinafter referred to as MOA).

6. Potential to take Risk- The non-financial companies' potential to take risk is slightly limited in terms of quantum and execution of its policies due to the above-stated limitations viz a viz the PSBs.

Apart from these, it is necessary to note that non-financial companies cannot go outside the purview of their object clause. This is because, even if it is accommodated somewhere in the non-financial company’s MOA, they would still lack the required expertise, knowledge, and experience to execute it to its potential.

Moving forward, we can further analyze other case studies signifying how the government always prioritizes PSBs over non-financial companies. One such example of it is “Moratorium.” Moratorium means allowing a temporary deferment of interests to pay off the cumulative interest in one go. If not fully paid, compound interest will be charged in addition to the cumulative interest. In short, even if the term increases, interest will still be levied. Now, taking into consideration the present scenario in India, many have not been able to pay off the interest on expiry of the moratorium period because of the aftermath of the Coronavirus, which has been also reflected in the balance sheets of most of the banks and non-financial companies. Seemingly, the government has still decided to recapitalize the PSBs over the struggling non-financial companies, who might even be facing a liquidity crunch, showcasing the preferential treatment. This is because, as established above, PSBs form the core of the economy. Another case study that can be considered is that of Yes Bank. Even when Yes Bank, which is a private sector bank, crumbled, the State Bank of India (SBI), which is a PSB, bought a 49% stake in it. Thus, not just non-financial companies, but even private sector banks are protected by PSBs, although through government intervention as per the compliance norms of the government.

To conclude, irrespective of banks being subject to the public or private sector, their ability to in or out cash funds through deposits, coupled with their low capital to asset and cash to asset ratios, subject them to high liquidity and capital buffers. Thus, bank failures, coupled with the recession caused due to Coronavirus, can have a domino effect on the economy. Therefore, any liquidity crunch caused by banks failure, especially PSBs, would have an irreversible and Streisand effect on the businesses and public in general. This is because, PSBs are subject to more direct government supervision and involvement, and thereof guarantees financial soundness to the public. Subject to PSBs acting as “arms of government policy,” the trust erosion caused by PSBs failure would be unmatched with any non-financial companies failure. Thus, as recap schemes established in the legislative history suggest, India has established an unsaid rule of not allowing the PSBs to fail. Bailouts act as a safety net to the economy through the banking sector. Therefore, any kind of preferential treatment given to the PSB is deemed necessary as it is to sustain the money supply and asset management in the economy. Thus, as established above, the health of the economy is driven by PSBs.

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Aditya Vohra

A final year law student at OP Jindal Global University.

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