Viral Acharya - Part Two

The problems with Viral Acharya's take on public-sector banks are manifold. It lacks any sort of nuance - suffering from a metric-driven, philosophically-blinkered, impoverished outlook that cannot see any solution other than privatization.

  • It ignores the recent criticism that the large private banks are de facto guaranteed as well. That's what "too big to fail" means.

  • It fails to see the financial system as an amalgamation of both the public and private. If the Indian financial system was more stable, it need not have been because of the PSBs. But it might be because of the relationship between PSBs and private sector banks and other government and non-governmental institutions.

  • It assumes that public and private institutions have the same objectives and should be judged by the same criteria. Public institutions are ruled by something other than a profit motive and will behave in different ways.

  • It doesn't seem to see the difference between Indian PSBs and US institutions like Fannie Mae and Freddie Mac, that Acharya feels behaved worse than private banks pre-2008 and were "guaranteed to fail" as he has written elsewhere.

  • One of his arguments for a level-playing field between private and public players is what effect this inequalities will have on the behaviour of private players. It boggles the mind that he feels that a system that incentivizes the wrong behaviour from private players will be solved by further privatization.

How will the private sector banks in India respond to the emerging strength of PSBs? Will they undertake greater risks and leverage in order to compensate for their likely underperformance when the next crisis hits? Can India afford such a race to the bottom when over 70 percent of the banking assets are funded in a manner that effectively represent off balance sheet liabilities of the government? ... Would nonbank financial firms develop a world of “shadow banking” for the private financial sector to park risks away from scrutiny of the RBI? Would it not be better instead to create a level playing field where all financial firms are private, but are charged upfront for government guarantees in the form of deposit insurance (up to reasonable ceilings), allowed to branch freely in rural areas as growth demands, and subject to a clear resolution authority, so that both financial firms and their borrowers undergo creative destruction and are, thus, incentivized to innovate and experiment?"