Banking Sector Reforms

Explained: 50 years of Bank Nationalization in India

Note4Students

From UPSC perspective, the following things are important :

Prelims level : Read the attached story

Mains level : Nationalization of banks in India and its impact

  • This 19th of July marked 50 years of nationalization of banks in India.
  • The govt. under Indira Gandhi carried out bank nationalization through an Ordinance in 1969.
  • 14 big private banks were nationalized to help agriculture and social welfare programmes.

Background

  • In 1955 Imperial Bank of India was nationalized as RBI with State Bank of India to act as the principal agent  for extensive banking facilities on a large scale, especially in rural and semi-urban areas.
  • The other banks of the princely states were acquired by SBI much earlier.
  • However, the nationalization of banks in 1969 and later in 1980 was of a completely different scale.
  • In 1969, the move covered 14 (followed by six in 1980) of the largest private sector banks—putting 85% of the deposit base into the hands of the government.
  • This brought 80% of the banking segment in India under Government ownership.

Why nationalization of banks?

  • After independence, the Government of India (GOI) adopted planned economic development for the country.
  • Nationalization was in accordance with the national policy of adopting the socialistic pattern of society.
  • The actual course came at the end of a troubled decade when India had suffered many economic as well as political shocks.

Other reasons

  • Social welfare
  • Controlling private monopolies
  • Expansion of banking to rural areas
  • Reducing regional imbalance to curb the urban-rural divide
  • Priority Sector Lending
  • Mobilization of savings

Immediate causes

  • There were two wars with China in 1962 and Pakistan in 1965 that put immense pressure on public finances.
  • Banks were failing largely due to speculative financial activities when Indira Gandhi became the prime minister in 1967.
  • 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.
  • Subsequently, a three-year plan holiday affected aggregate demand as public investment was reduced.
  • 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.
  • The collapse of banks was causing distress among people, who were losing their hard-earned money in the absence of a strong government support and legislative protection to their money.

Post-nationalization challenges

  • Having ownership and operational control of the banks was a challenging task for government.
  • The banks were constantly challenged on their profitability parameters—particularly RRBs which had both geographical and portfolio concentration risks.

Establishing regional balance

  • The objective of social control was about making banking sector accessible in areas where these services were not accessible.
  • The state established 196 Regional Rural Banks (RRBs) between two nationalizations.
  • While nationalization, branch licensing policy and priority sector lending targets helped the banks to go to rural areas and certain sectors, it did not achieve regional balance.
  • Of the 20 banks that were nationalized, seven were concentrated in south India, six in west India, four in north India and three in east India.
  • The expanded rural branch network followed the extant regional concentration, bringing more intensive banking in southern and western regions.

How was regional balance achieved then?

  • This skew was partially set right by two initiatives. The first was an institutional intervention of opening 196 RRBs which had focused area of operation.
  • The RRBs contributed significantly to reduce the regional imbalance with their expanding branch network in the 1980s.
  • RRBs also had a greater proportion of their loans flowing to priority sector in general and agriculture in particular.
  • The second was the policy on lead bank scheme where one bank was assigned as a lead for each district.
  • The lead bank was responsible for the growth and penetration of banking in districts and had to achieve it in coordination with other banks and the state machinery.
  • A “district credit” plan (euphemism for a banking plan), dovetailed with the government schemes, was to be prepared and monitored by the lead bank.

I. Regional Rural Banks

  • RRBs are a shade better when it comes to rural lending.
  • While they have deployed 72% of the rural and semi-urban deposits as credit in those areas, the figure for urban understandably is very low, and most of these funds have gone into investments.

II. Small Finance Banks

  • The new small finance banks (SFBs) give an entirely different picture—a large number of them are MFIs that converted into banks.
  • These institutions are trying to collect deposits from the middle and upper middle class and deploy those resources towards the poor.
  • From a paradigm point of view, possibly SFBs are the most interesting institutions that have turned the tables and are trying to achieve from the private sector the objectives set out in the bank nationalization.

Public versus Private Banks

  • A look at the broad performance ratios for 2017-18 shows that private sector banks score better on efficiency and profitability parameters.
  • They have better return on assets, return on equity, net interest margin and a higher proportion of low-cost deposits.
  • On the other hand, public sector banks (PSBs) have a better impact on priority sector lending achievement, and paid higher wages.
  • Of the new Pradhan Mantri Jan Dhan Yojana accounts 77% were opened by state-owned banks, 20% by RRBs, and a mere 3.4% accounts were opened by private banks.
  • From this perspective bank nationalization was indeed a good move at that time.

What benefits do we reap today?

  • Banking under government ownership gave the public implicit faith and immense confidence about the sustainability of the banks.
  • Banks were no longer confined to only metropolitan or cosmopolitan in India. In fact, the Indian banking system has reached even to the remote corners of the country.
  • The present government has reached out to people through banks.
  • Assistance for constructing toilets under Swachh Bharat programme, DBT, Crop insurance schemes etc was given through banks.
  • The dispensing of Mudra loans to about 20 crore individuals, benefits under PM Kisan scheme for providing cash assistance to close to 15 crore farmers annually are only possible through this banks.
  • Thus banks became the government’s dispenser of goodies due to the decision which was taken 50 years ago.

What about Financial Inclusion?

  • The All India Debt and Investment Survey reports indicate that the formal sector has been losing ground to the informal sector in the rural indebtedness pie since 2001 onwards.
  • This is worrying and indicates that the inclusion agenda is far from achieved.
  • Some examples in the public sector banking system—particularly SBI—have shown that it is possible to achieve the double bottom line of being in the commercial market while continuing to achieve significant targets in inclusion, sectoral, spatial and geographical.

Way Forward

  • From the larger perspective of efficiency and better utilization of capital, it may be a good idea to move state-owned banks towards more market-based framework.
  • However, that call should be taken to achieve the residual task of inclusion.
  • Making state-owned banks more autonomous and accountable to the market may be the first significant step that can be taken for now.
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