Fraud at Indian bank spurs calls for privatisation

Fraud at Indian bank spurs calls for privatisation

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In 1969, India’s then prime minister, Indira Gandhi, transformed the country’s banking landscape when she nationalised its 14 biggest commercial lenders, which together accounted for around 70 per cent of the system’s deposits.

Nationalisation was touted as way to protect depositors and force banks — which mainly catered to big industrial houses — to lend to a broader swath of the population, including farmers, traders and small businesses. 

State dominance over the banking system has not worked out so well for India. Politically driven lending decisions, difficulties agreeing realistic debt workouts when loans sour, as well as uninspired, even fearful bureaucratic management and outdated IT systems have left state lenders with a far higher bad debt burden than their private rivals, hindering India’s economic prospects. 

Now, the discovery of a $1.8bn fraud at India’s second-largest state lender, Punjab National Bank, is prompting vigorous and concerted calls for New Delhi to admit the failure of Mrs Gandhi’s bank nationalisation — and reverse it. 

According to PNB, staff at one of its Mumbai branches issued fraudulent bank guarantees for luxury jeweller Nirav Modi, and his diamond-trader uncle Mehul Choksi, to take cash advances from the overseas branches of other Indian banks — all ostensibly guaranteed by PNB. 

The public-to-private lending model has proved toxic

Antiquated software systems — guarantees were issued without requisite documents or collateral — meant PNB’s management had no idea of the obligations mounting in its name. Nor did the banks that received the guarantees, mostly other state lenders, suspect any impropriety. 

Analysts say the scam, which PNB says went on for several years without detection, highlights the rot in state banks and the need for radical change. 

“The legacy of Indira Gandhi is toxic, and the Indian economy must be cleansed of it,” Meghnad Desai, the Indian-born economist, wrote in the Indian Express. “The government should privatise the banks as soon as it can . . . [They] have been a drain on the economy, and a huge cost to taxpayers.” 

Industry bodies — and prominent industrialists, such as Adi Godrej — have echoed the call. 

The Confederation of Indian Industry urged New Delhi to reduce its shareholding in state banks to just 33 per cent, calling it “unavoidable” to ensure better management, and greater accountability. The Federation of Indian Chambers of Commerce and Industry says New Delhi should keep control over just two or three large banks. 

Arvind Subramanian, the government’s chief economic adviser, last year concluded “the public-to-private lending model has proved toxic”, and urged major reforms to avoid repeating the problems of the past. Even Ravi Venkatesan, chairman of state-owned Bank of Baroda, conceded “privatisation of a few big banks is probably the only solution”. 

Many had hoped prime minister Narendra Modi’s government would undertake fundamental bank reforms as part of comprehensive economic modernisation programme following his decisive 2014 election victory. 

But aside from passing a new bankruptcy law, Mr Modi’s government has shown little appetite for a radical shake-up of the banking sector, or its ownership. With national elections next year, that seems unlikely to change. 

Arun Jaitley, finance minister, has pushed back against the clamour for privatisation, saying it was unlikely to find favour with “Indian political opinion”. 

He has insisted that the PNB fraud raises questions not about the banks’ ownership but about regulation and supervision by the Reserve Bank of India, the central bank.

At the heart of India’s banking crisis, however, is New Delhi’s political control over what should be run as commercial entities and the inherent conflict of interest in the state’s multiple roles as economic policymaker, the largest bank owner and the industry regulator. 

While New Delhi is now in the middle of a $32bn recapitalisation scheme to shore up bank balance sheets after the last wave of bad debts, the PNB fraud has raised fears the government is simply throwing good money after bad. 

Privatisation of some, or even most, of India’s state banks is not a simple or quick solution to the sector’s problems. Analysts say the legacy of five decades of state ownership — and its impact on personnel, incentives and decision-making — will take years to undo. But the PNB fraud has persuaded many Indians it is time to start.

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