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Comments on “Is State Ownership in the Indian Banking Sector Desirable?”

Comments on “Is State Ownership in the Indian Banking Sector Desirable?”. This is a provocative paper which considers the lessons to be learned from the financial crisis for Indian financial reform.

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Comments on “Is State Ownership in the Indian Banking Sector Desirable?”

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  1. Comments on “Is State Ownership in the Indian Banking Sector Desirable?” This is a provocative paper which considers the lessons to be learned from the financial crisis for Indian financial reform. The analysis addresses the argument that state owned banks are less vulnerable than private banks to financial crises arising abroad. This argument is based on the observed shift of bank deposits away from private banks, including foreign banks, toward public sector banks in 2008. The primary empirical finding is that differences in bank exposure to systemic risk do not explain this shift.

  2. Findings and primary conclusion: The distribution of MES measures for 2007 do not appear to differ between public sector banks and private banks, but deposit growth for 2008 systematically differs between these. Deposit growth declines with MES for private banks and significantly rises with MES for public sector banks. These findings do not confirm that deposits shifted towards state banks because they had lower exposures to systemic risk, but they are consistent with state banks being perceived as less risky for depositors. The main conclusion is that the explicit government guarantee of deposits in public sector banks attracted deposit growth while deposit growth fell or became negative for private banks. The paper also suggests that state ownership of banking could increase crisis vulnerability.

  3. Comments – deposit migration: Why are higher MES related to larger relative increases in deposits for public sector banks? Could this result be due to omitted variables (other characteristics of the banks such as size)? Foreign banks suffer larger declines in deposit growth and credit growth in 2008 relative to domestic private banks. The role of deposit insurance could be discussed in more detail. All commercial banks, including foreign banks, are required to insure deposits with the DICGC. Certain deposits are excluded, for example, interbank deposits and deposits received outside India. More detail on the composition and distribution of deposits would be helpful. Is there a difference between the holdings and behavior of NRI and other foreign depositors and domestic depositors? Are these more concentrated in private banks that in state banks?

  4. Comments - interpretations: The paper’s argument that the explicit guarantee of public sector banks is a better explanation of the shift than relative riskiness of the banks makes sense. However, the discussion of the role of public sector banks and arguments in favor of privatization are sparse and need to more explanation, nuance and reference to research on bank lending in India. The data in the paper reveal that state banks were not less vulnerable than private banks on the eave of the 2008 crisis. This says that state ownership should not be credited with raising the resilience of the banking sector to financial crises. This point ought to be expanded by explaining how preferential government guarantees of deposits in public sector banks over private banks can affect crisis vulnerability.

  5. Analogy to the mortgage GSEs in the U.S. Fannie Mae and Freddie Mac are publicly-held corporations that enjoy implicit government guarantees and are directed to lend in the interest of social goals. With insufficient regulatory restraint, managers have incentives for risk taking and private lenders might anticipate intervention by the GSEs in the mortgage market in a credit crisis. The parallel features of Indian public sector banks are government guarantees, lending directives and equity issuance. The implication is that because the US mortgage GSEs were at the center of the housing boom and the mortgage securities market that the similar institutional structure of public sector banks in India could also lead to financial crisis. This is a huge leap without analysis. To use this analogy, a lot more theory and empirical detail are needed.

  6. The consequences of state ownership and privatization for financial stability The paper’s discussion of the role of public sector banks and arguments in favor of privatization are sparse and need to more explanation, nuance and reference to research on bank lending in India. The problems for financial stability posed by state banking in India need to be explained and articulated in terms of the characteristics of Indian banking and finance. Regulatory policies matter and should be part of the discussion of the consequences of state and private ownership for financial performance and stability. Privatizations have often contributed to crises attributed to explicit or implicit government guarantees and regulatory failures. This is analogous to the two US GSEs. Bank nationalizations are more often associated with too little lending.

  7. The role of state banks The statements that public ownership of banks in India hampers productive lending to agriculture need substantiation via references. There is a literature on how state and private banks lend in India and whether firms are constrained in access to loans. Banerjee, Cole and Duflo find empirically that firms are credit-constrained and that marginal productivities of investments finance by banks greatly exceed interest rates charged. They also find a stark example of lazy banking: bankers generally renew loans in the original amount in nominal terms without responding to borrower performance. Burgess and Pande find that the RBI’s branch expansion policies between 1977 and 1990 increased rural bank lending and reduced the role of moneylenders and was associated with poverty reduction and the diversification of rural investment.

  8. Does the composition of deposits matter? Banks in India reveal a preference for investing in government debt and this tendency is more pronounced in public sector banks. An interpretation might be that the shift of deposits to the public sector banks results from domestic depositors seeking to hold more government bonds (that is, deposits against reserves) in addition to the benefits of deposit guarantees. Could it be that NRI depositors moved to U.S. treasuries and domestic depositors to GOI debt? If so, then flight to safety could result in a rise in holdings of the least risky assets available to different depositors. Small holders might increase deposits in the domestic banks to which they have access, while foreign depositors (or domestic investors with access) might shift to foreign assets in the crisis. There is a sharp rise in the capital account surplus during the 2008 fiscal year (notably in the calendar year third and fourth quarters).

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