IDBI Bank Deal Travails Show Pain Ahead For PSU Bank Privatisation

Finance Minister Nirmala Sitharaman said on Saturday that there was no update on the proposed privatisation of two public sector banks that was originally announced in the Union Budget for 2021–22 (Apr–Mar).

This shows limited progress on this issue nearly two years after the announcement.

Even the 2023-24 budget speech did not provide any insights on privatisation of state-owned banks, except for a change in the law aimed at making strategic disinvestments such as IDBI Bank more attractive to potential bidders.

The government now aims to allow the carry forward of such losses to enable such stake sales to attract more suitors who may be concerned about legacy issues on the balance sheet.

This goes to show that despite various attempts and announcements that the government was looking to privatise IDBI Bank, two public sector banks, and two state-owned general insurance companies, there has been little headway.

Let’s take the example of IDBI Bank. In the 2016–17 Union Budget, then-finance minister Arun Jaitley announced that the government was looking to pare its stake below 50%.

In 2016–18, the government held hectic parleys with multilateral agencies, foreign banks, local banks, and non-bank lenders but was unable to attract any interest. This led the Life Insurance Corporation of India to be roped in as a "white knight" to take a majority stake and become a co-promoter with the government of India.

So purely technically, the government stake is now below 50%, since it currently stands at 45.48%. But it remains a promoter of the bank, along with the state-owned Life Insurance Corporation of India, which owns 49.24%. This means the direct and indirect government holding in IDBI Bank is 94.71% even today. Curiously, the regulator, the Reserve Bank of India, considers IDBI Bank as a private bank for regulation and supervision needs.

At the time, IDBI Bank needed a fresh equity infusion to manage legacy bad assets and capital erosion, and LIC proved to be the only investor ready to step in.

On Feb 1, 2020, Sitharaman announced that the government wanted to divest its entire stake in IDBI Bank. In end-2022, the government finally called for an expression of interest in the purchase of a 60.7% stake in IDBI Bank, with both the government and LIC selling a little over 30% to a prospective buyer.

By legal standards, it was easier for the government to push through IDBI Bank as it was incorporated under the Companies Act and not a state-owned bank under the nationalisation laws. This meant that there was no legal barrier to the government's stake falling below 50%.

This won’t be the case for other public sector banks, where there will have to be legislative changes made to even initiate a process to sell or even pare the government stake below 51%.

The government has allowed some easing of norms in this process to enable a wider pool of domestic and global investors to participate in the bidding process. Although there has been initial excitement and bidding for the IDBI Bank stake sale, it remains to be seen whether the bid pool comprises quality investors that will pass muster on the RBI’s stringent fit and proper criteria and security checks.

There is already opposition from bank employee unions against the privatisation of IDBI Bank and the proposed privatisation of more banks.

Already the protest strikes by unions are picking up pace, although the efficacy of such strikes has been affected by the increasing shift away from branches to digital by customers. However, the staff unions remain a key player that needs to be taken along if the government wants to successfully hand over the management control reins to a private sector player.

The government will do well to consider some of the genuine concerns of stakeholders regarding the proposed privatisation of state-owned banks.

An important concern that needs to be weighed by the government, the RBI, and any potential investor is whether a bank that does not remain a public sector bank will attract the same level of trust from depositors and investors. Over the years, the sovereign-backing premium has been implicit in the faith reposed in state-owned banks by customers, rating agencies, and investors. The rating and outlook will be a crucial factor since they will have a direct impact on investor perception of existing equity and debt issues and on future fundraising prospects.

Could we see depositors shift away from such privatised banks once they stop being government-owned? In that case, will the investors be deep-pocketed enough to manage this costly transition to a higher cost of deposits to run basic operations? Many state governments, companies, and individuals tend to keep money in deposits only at state-owned banks as a risk mitigation exercise due to the negligible risk of institutional bank failure. This may mean there is a need for additional capital infusion from the same investor in case of a crisis, so their ability to do so will be a key factor when the selection of a successful bidder happens.

Even in IDBI Bank’s case, will the staff be comfortable continuing if the successful bidder is a foreign player? Will the RBI be comfortable with a foreign player that it has limited regulatory control over and seek the investment to be domiciled in India?

There will be close scrutiny on who the successful suitor will be and how they go about the process of privatising IDBI Bank, not just in terms of ownership but also employee culture and service quality. To ensure that there is no risk to the institution as a result of this ownership change, the investor will need to work closely with the regulator, government-LIC, and staff.

Will the government and the RBI allow an existing private bank to promote another bank without merging it with itself? If yes, then the pool of bidders will be much bigger than if the acquiring bank is forced to merge with IDBI Bank.

Another key question is whether the government will be prepared to provide more incentives to sweeten the pot for potential investors in financial sector entities.

To be fair, this government has shown with Air India's divestment and LIC's initial public offering that it has the necessary political heft to push through its announcements despite opposition from many circles. This will also be a comforting point for investors looking to invest in a public sector bank.

However, banking is a trust-based business where common people place their money as a deposit with an institution based on trust. Even if the government and RBI approve a new investor for IDBI Bank or other state-owned banks, it will be important to see if the public continues to repose their faith in such banks that are not part of the public sector umbrella anymore.

IDBI Bank is a litmus test for not just the lender but the entire bank and insurance sector privatisation that the government has embarked on.

The slow and arduous journey from 2016 to today shows that, unlike privatisation in other businesses, the privatisation of financial sector entities will remain a tough sell to all stakeholders.

T Bijoy Idicheriah is a senior financial journalist who has been writing on the world of banking and central banking for 17 years.

The views expressed here are those of the author, and do not necessarily represent the views of BQ Prime or its editorial team.