The announcement by the finance minister (FM) that privatisation of two public sector banks (PSBs) and a general insurance company would be considered during this financial year has been greeted by commentators on the Budget as a major reform in the offing. The present article does not seek to debate the merits of the decision but rather dwells on the process that can be considered.
Privatisation of businesses currently run by the government should be effected in a manner that the value realisation to the owner is maximum and the statement by a senior functionary of the government to the opposite was quite surprising.
It is also essential that the process creates opportunity and space for more bidders to help discover the best value and to make it possible for the assets to find the right owners who can work it more efficiently in future for the benefit of the economy.
The common route for privatisation, whenever accomplished in the past, was for the government to sell the shares of the company, partly or wholly, to a qualified bidder. An exception was the sale of Centaur Hotel.
This perhaps was seen as the most facile way to achieve the objective of passing on ownership. May be the type of companies sold didn’t require a serious evaluation of an alternative mode.
However, in the context of the banks likely to be on the block soon, it is useful to look at an alternative structure to achieve the objective of getting the best value for the assets sold, and to open the process to a wider audience of bidders.
In the case of the two banks, whichever they be, selling of controlling interest through shares will significantly narrow the potential bidders. This will practically rule out all existing players in the industry.
The reasons are obvious as none of the private banks would see merit in aggregating a huge network of physical branches at a cost and add a lot of legacy that may be little desired.
Foreign banks will be equally hamstrung, given the regulatory limitations and the current unincorporated structure under which most of them operate.
Non-banking finance companies (NBFCs) may be equally at a loss to see value in a leviathan that comes with more problems than opportunities.
In some sense, the field will be limited to a few Indian business houses that are keen to enter banking.
While the jury is still out on the virtues or otherwise of letting business houses into banking, the restricted field will be counterproductive in terms of getting the best value for the money on the table.
The PSBs have, in most cases, significant real estate, including heritage buildings in some metros, which were actually the heirloom of the erstwhile owners of these banks before their nationalisation in 1969!
These will be grossly undervalued in a typical valuation model that overemphasises future profitability and under-stresses the value of immovable and other properties.
The other factor is that, unlike a refinery or a shipyard, which is a monolithic business, in services industry the business units are more atomic and virtually each branch of a bank may be a distinct asset.
Opportunistically, some of the existing players in the industry may covet some of the branches and may be willing to pay a premium to get them.
In fact, a new entrant may just desire the brand name of the bank on the block than its assets, customers, or employees. For example, a large NBFC with a strong existing franchise may just need a well-known name in the Indian banking business to kick-start its foray than taking over an apparatus that comes with innumerable issues.
The most prickly issue will be some level of cleaning the augean stable of bad loans to facilitate successful privatisation. It will be quite difficult to meaningfully segregate and value appropriately before putting into an asset reconstruction company (ARC) or whatever set up the government is looking to create for this.
Even the loans that are currently not marked as non-performing asset (NPA) may be microscopically checked in valuation by any potential bidder. In some sense, while the liabilities of the banks under the hammer are well crystallised its assets are of dubious value in a sale.
Therefore, there is merit in looking at selling piecemeal assets of the bank packaged cleverly to maximise realisation and to make it possible for a significantly larger pool of bidders to participate.
The ideal would be to retain all doubtful loans in the current bank along with all other assets like real estate that is failing to fetch the best price. Many of the real estate may get much better price if sold to typical developers or others who seek such properties.
Similarly, if the bank is owns shares in companies by virtue of past investments or loan conversion all that needs to be strategically sold and will lose value when bundled.
The two banks that are on the block can both after being stripped of the assets that the bidders are keen on, actually become the ARCs or the bad bank that the government is so keen to set up, to address the bad loan problem!
If this model succeeds, this becomes the template for the rest of the PSBs.
Though currently the identity of the two banks is not known, it is most unlikely that any PSB has a positive net worth after duly accounting the NPAs and even if some level of revaluation is done of the real estate. In some sense PSBs are in a situation like the Tamil Nadu-based Lakshmi Vilas Bank Ltd (LVB).
In the case of LVB, the shareholders and the bond-holders were given a full tonsure. This is in litigation. The same may be a reality in the PSBs.
The government may be fine not to seek a value for its portion of the shares, but the public holders and especially the tier 1 bond-holders will be seriously aggrieved.
By selling assets and getting a patient and fair resolution to NPA the residuary bank may be able to liquidate the bond-holders and offer something back to shareholders. At least, the basis of what destiny finally awaits these will be more transparent and not like a peremptory closure as it happened in LVB.
There is definitely a reason to debate this suggestion than believe that there is only a single way to privatise. In its own interest, the government should crowd source ideas on this subject and a well thought out process can actually stand in good stead when more banks or other PSUs come on the block.
In fact, when banks were nationalised, the shares were not acquired compulsorily but the undertaking of the erstwhile private banks was taken over and the compensation was paid to the companies concerned which, in turn, dealt with the disbursements to the rightful claimants.
(The author is a CA and CS and retired as a partner at EY, Chennai heading tax and regulatory advice.)