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All About Privatization of PSBs

The Finance Minister’s budget speech did include the paragraphs regarding the government's intent to undertake the privatization of select PSBs.

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With news reports expanding on the government's resolve to undertake the privatization of select Public Sector Banks (PSBs) in the coming fiscal (April 2021-March 2022), here are some basics on why this move and what happens. News reports have listed out some names including that of the Bank of Maharashtra, Bank of India, Indian Overseas Bank, and Central Bank of India as among those that may see the privatization drive in the coming financial year.

Why is the government looking forward to this?
Privatization of banks simply means less active and direct participation of the central government in the day-to-day activities of the banks. In effect, the majority stake held by the central government is the PSB will be offloaded in favor of private investors. For banks, it means more competition in the market and lesser to negligible financial dependence on government funds. It has been widely reported for a long time that some of the state-run banks not been performing to their potential due to a variety of reasons and are heavily dependent on the financial support provided by the central government. The reported increase in the NPAs (Non-Performing Assets) of some of the PSBs continues to pose working challenges and can get classified as bad debts over a period of time.  

After the country witnessed a pandemic and a decline in the country’s economy, it is projected that gross NPA ratio of banks will increase from 7.5 per cent in September 2020 to 13.5 per cent in September 2021, reported in the RBI’s recent Financial Stability Report. "This will further lead to more capital flow from the government to the public sector banks," the report stated. 

In the last couple of years, the central government has invested large amounts through recapitalization bonds and capital injections—Rs 70,000 crore (Financial Year 2019), Rs 80,000 crore (Financial Year 2018) and Rs 1.06 lakh crore in FY19 as recapitalization bonds.  

Through the privatization drive, the government wants to strengthen the better performing banks while aiming to reduce support to those that may be underperforming now but have the potential to become future performers post-privatization.   

What happens after privatization of Public Sector Banks (PSBs)?

  1. It is widely expected that post-privatization, the new management of the private entity will be profit-oriented. Also, once privatized, the management will strive to reduce the NPAs.
  2. Post privatization, there could be a scenario that the banks will be forced to re-look at their retail operations. The fear is that once privatized, there could be possibilities of maintaining branches that are profitable and opposed to those that may be struggling. This may also result in a complete re-look of the human resources employed with the bank.   
  3. Post privatization, some of the free services provided by the state-run banks like Passbooks, ATM Cards, Cash deposit, etc. will get converted to paid model.
  4. For the government, privatization drive would mean better utilization of its financial resources - instead of continued pressure to re-capitalize such banks at regular intervals, the central government can better utilize those funds towards poverty alleviation and other public projects. 
  5. For customers, the baking services at a privatized bank are expected to see more improvement due to competition from other private sector banks.   

How will the banks be selected?  

The privatization gathers to a big move which usually takes a long planning and a strong execution policy. The two banks which are to be privatized will be selected through a process in which NITI Aayog will first make its recommendations based on detailed research and analysis. The process of privatization is not an immediate one and is likely to begin in FY 2021-2022 and may take several months.  

How has the news affected the stock markets and why were PSB stocks rallying? 

The Nifty PSU index has added over seven per cent in the week ended February 19 after the news of privatization of PSBs turned the traders to take fresh positions into the stocks. Strong buying in the stocks of Canara Bank, Bank of India and Central Bank was witnessed as the traders expected for a positive recovery in these banks after the government proposed move. However, the rally was paused in the last trading session of the previous week as traders booked profits. Hopes of better development and strong returns in the future after the decision is what attracted the traders.  

How do you see this move on the market front and is this a good pick to invest or to trade?

Likhita Chepa, Senior Research Analyst at CapitalVia Global Research said:

After the news that hit the market there is a big speculation on which two PSB's will be privatized. Few expect that the two banks may be from six PSBs – Bank of India (BoI), Bank of Maharashtra (BoM), Central Bank of India (CBoI), Indian Overseas Bank (IOB), Punjab & Sind Bank, and UCO Bank – which were left out from last year's mega-mergers, and some also believed that there is a possibility that the government may choose two major banks from the consolidated banks or the government may pick one from each group. "Unless the government shows the road map and announces the name of the banks, the traders should be cautious about the speculation around PSU’s. It is recommended that investors should not pick the banks on the basis of such news; rather it is safer to evaluate them and make a better decision,” Chepa said.  

Rusmik Oza, Executive Vice President, Head of Fundamental Research at Kotak Securities, said: 

“The privatization of PSU banks is good for the overall basket. In the recent Union Budget, the Government has earmarked just Rs.20, 000 crore towards the recapitalization of PSU banks at a time when the RBI Financial Stability report has warned of Gross NPAs shooting up to 14.8% in the worst case by Sep’21. As per the RBI report, the projected Gross NPA of PSU banks is forecasted to rise from 9.7% in Sep’20 quarter to 16.2-17.6% in Sep’21 quarter (in the worst case). The creation of a bad bank kind structure is good for PSU banks as it can absorb most of the NPAs sitting in their books and also reduce the need of large recapitalization. The government has already merged some of the smaller PSU banks with larger ones and is aiming to have only few large PSU banks remain in the system. "As and when the first two PSU banks get privatized, we can expect a re-rating in PSU banks valuations. Due to lack of clarity and better prospects of credit offtake in future we would like to stick with SBI and Bank of Baroda in the PSU pack," Oza said.  

Is the rally sustainable in the PSBs? 

“We except RoE (Return on Equities) of the top PSU banks like Bank of Baroda, PNB and SBI to improve to 12-15% in FY23. There is a case of sharp earnings growth also materializing in case of PSU banks going forward. Considering these two factors we expect a re-rating in the valuations of PSU banks. To this extent the rally in SU banks seems to be sustainable in the medium to long term”, Oza said.