50 years ago, the Indian financial sector underwent a tectonic shift, when Indira Gandhi government nationalized the 14 biggest commercial banks in 1969. The impact of this decision is considered by some to be, even more than the economic reforms of 1991.
The factors that led to the nationalization of banks
Nationalisation was in accordance with the national policy of adopting the socialistic pattern of society.
Political and Economic Reasons-
o There were two wars (with China in 1962 and Pakistan in 1965) that put immense pressure on public finances.
o Two successive years of drought had not only led to food shortages but also compromised national security because of the dependence on American food shipments (PL 480 program).
o Subsequently, a three-year plan holiday affected aggregate demand as public investment was reduced.
o The decade of 1960-70s was the lost decade for India as the economic growth barely outpaced population growth and average incomes stagnated.
o Industry’s share in credit disbursed by commercial banks almost doubled between 1951 and 1968, from 34% to 68% whereas agriculture received less than 2% of total credit.
Agriculture needed a capital infusion, with the initiation of the Green Revolution in India that aimed to make the country self-sufficient in food security.
Other reasons responsible for the nationalization of banks were-
o Social welfare
o Controlling private monopolies
o Expansion of banking to rural areas
o Reducing regional imbalance to curb the urban-rural divide
o Priority Sector Lending: In India, the agriculture sector and its allied activities were the largest contributors to the national income.
o Mobilization of savings: Nationalisation aimed at mobilizing the savings of the people to the
largest possible extent and to utilize them for productive purposes.
However, with the looming banking crisis in current times, debates have emerged about the privatisation of banks. This raises the question of whether nationalisation of the bank in the first place was the right move or not.
NPA crisis since 2012 is at least partly explained by the credit bubble that grew under political patronage that emerged out of government’s control over Banks.
There were different rates of interest for different types of loans. The Indian central bank eventually ended up managing hundreds of interest rates.
Nationalization of banks has led to lesser competition between the public sector and private sectors banks. This has created a bureaucratic attitude in the functioning, Lack of responsibility and initiative, red-tapism, inordinate delays are common features of nationalized banks.
The experience of the nationalized banks has shown that banks are now facing the problems of heavy overdue loans and economically unviable branches.
o Extending loans to agriculture and small scale industries is risky and less remunerative. Such loans are against the sound banking rules and may weaken the economic viability of these institutions.
Due to lack of performance audit of banks, policy-making failed to ensure that the finance from the public institutions are, in fact, going to productive uses in the large public interest.
Given the significance of a vibrant banking system in the growth story of the nation, privatisation of banks is proposed. However, privatisation of banks is not a panacea. India must not make haste in going for the privatisation of banks, rather it must focus on comprehensive governance reforms, resolution of NPAs and creating a free market so that investment can be reinvigorated and wheels of the economy can again get back on track.