Wednesday, February 28, 2018

Banking crisis

Is privatization of Indian banks a good idea?

That is the question a lot of people are asking these days after major scams in PNB and other state-owned banks.

Privatization will certainly improve efficiency, customer service, accountability etc. That's what private enterprises bring to the table. Without being efficient and effective, you can't survive in the competitive world of private business. You will also be more careful with lending money because it is YOUR money. In case of state-owned banks, it is THEIR money. At least that's how it is treated.

But, does privatization provide safety and security to the hard earned money of common and laypeople deposited in banks?

That's is doubtful. All over the world many private banks keep going bankrupt and in the process completely wipe out depositors, shareholders, creditors and everybody.  Total clean shaving. It has happened over and over again. Even in India we see many privately owned banks, cooperative banks etc. going out of business. Many times promoters vanish without a trace. Along with them vanishes all the money.

Even here in the USA, banking has not been a very reliable sector. All banks are private here. But government has had to support them in the times of crisis. Example: 2008 financial crisis. Without government support, many large banks would have gone belly up and destroyed the entire financial system in the process. When some large banks like Lehman Brothers, Washington Mutual were allowed to fail, it became clear that letting only the fittest survive was not an answer as there were no really fit banks. Government lent close to 750 billion dollars to the banks. Good news is, at least per the government, we are making money on the money lent to banks as they are paying them back to government with interest. Good deal. Right? :)

Private banks going out of business and completely wiping out depositors has happened in a major way at least twice in US banking history. Once was in 1930's during the great depression and second time was in 1987 during Savings and Loan (S&L) crisis.

After the 1987 S&Lcrisis, the US government devised a scheme called FDIC (Federal Deposit Insurance Corporation). This institution provides insurance to the money deposited in banks. All banks have to insure their deposits by paying premiums to FDIC. Banks pay the FDIC premiums using a portion of interest amount that they would have otherwise paid to depositors. They will pay, say 0.25% interest, towards FDIC insurance premiums and rest to you as the interest on your deposit. In turn, FDIC guarantees your deposits up to a certain amount in case of bank going bankrupt.

Currently up to $250,000 is insured. This is per bank. So, I can deposit my money in multiple banks and be assured that it is safe. Since there are several private banks (all FDIC insured), $250,000 per bank is more than enough to guarantee that even a large sum like say two and half million dollars is safe as long as I deposit it in say 10 different banks. (250,000 x 10)

India can consider a similar mechanism. Instead of government owning the banks, government should provide deposit insurance. For India, the limit may be say 1 crore per customer per bank. A well-to-do citizen may have, say 10 crores, of hard earned money. By providing deposit insurance up to 1 crore, his savings are protected as long as he deposits no more than a crore in one particular bank.

Something to think about.

This will work only if the amount insured is reasonably high. I read somewhere that the current government proposal in India is to insure up to 1 lakh rupees. That will be too low. Even a very common man at the time of retirement or anytime will have a few lakhs with him. He wants absolute safety for that amount. So, insuring up to only one lakh will be too low. If it is only one lakh, then you will have to find at least 10 banks to deposit your money assuming 1 lakh insurance is per bank and not for deposits in all banks put together.

All around the globe the financial industry will continue to have scams. That's the nature of human greed. You can't completely avoid it or eliminate it. You can provide safety by insurance, better checks and balances etc.

Privatization of banks will definitely bring efficiency and accountability. I don't think private banks would have lent money as recklessly as state-owned banks did to fraudsters like Mallya etc. I think the percentage of non-performing-assets (NPA) are significantly less in private banks.

To provide deposit insurance, the depositor may have to be satisfied with slightly low interest rates. That may be acceptable. Probably more than acceptable in India where interest rates are fairly high like 7 or 8% on fixed deposits. Here in USA, if you get around 2.5% on fixed deposits, that too on 5-year fixed deposits, that is considered as too good. In India, fixed deposits are good income generators, here they don't even keep up with the inflation. That's why one needs to invest in stock markets etc. to get better returns. Risk and return go hand in hand. 8% interest up to 15 lakhs for senior citizens is a commendable measure introduced in the recent Indian budget.

What's your take? Privatize banks but insure the deposits or keep the banks state-owned, inefficient, unaccountable and irresponsible?


sunaath said...

I know very less economy, personal or national! However your points make good sense. I hope India will follow suit.

Mahesh Hegade said...

Thanks for your comment, Sunaath Sir.