50 years of nationalisation

Status quo on banks will increase the burden on the exchequer

The Indira Gandhi government’s decision to nationalise 14 commercial banks 50 years ago on this day is said to be the most significant economic event after India’s independence. Though the decision was given an economic rationale, the underlying reason was more political. In 1980, the government took control of another six banks.

The idea of bank nationalisation, however, was not new. An internal committee of the All-India Congress Committee (AICC) recommended nationalising banking and insurance in 1948, which was endorsed by the AICC later in the year. After independence, the banking system had its problems and there were issues related to the reach and flow of credit to important sectors. For instance, the fragmentation was addressed through consolidation. The number of banks was brought down from 566 in 1951 to 91 in 1967, which made the sector more viable. Before nationalisation, the government tried addressing some of the issues through “social control”. The idea was to attain a wider spread of credit and increase the flow to priority sectors.

Although the issue of nationalisation kept surfacing from time to time, rising economic difficulties in the 1960s and the need to retain control in the party after some electoral setbacks prompted Indira Gandhi to nationalise commercial banks. Bank nationalisation resulted in a significant increase in bank deposits and financial savings, and the rising fiscal deficit made the banking sector a captive source of financing. With continued political intervention, profitability suffered. Over the years, this affected operations and a large part of the population remained outside the banking net until the launch of the Pradhan Mantri Jan Dhan Yojana in 2014.

Most public sector banks (PSBs) today are not in the desired position. The government has pumped in over Rs 2.5 trillion in the last few years — that includes Rs 70,000 crore in the current year— and it still may not be enough. PSBs continue to struggle with a higher level of non-performing assets.

There are multiple issues that need attention. First, the government does not have the fiscal space to continuously pump capital into PSBs. The idea of using recapitalisation bonds has its limits as it is increasing the government’s liability. Second, the role of technology in banking and finance is rising rapidly, and PSBs with their weak balance sheets are not in the best position to adapt and compete on this front. Naturally, the business will increasingly shift towards private sector banks. Third, it would be hard to implement the required reforms in PSBs in the present set-up. These banks, which account for 66 per cent of outstanding credit and 65.7 per cent of deposits, need functional and operational independence, which will always be difficult to attain with the government being the majority shareholder. Therefore, it should actively consider bringing down its shareholding in a systematic manner. It can perhaps revisit the recommendation of the Narasimham Committee on banking sector reforms in this context. Bringing down government equity to 33 per cent will not only give banks more functional autonomy but will also enable them to raise capital and compete in the market.

The 50th anniversary is a good opportunity to objectively review the performance of PSBs and take corrective measures. Maintaining the status quo will keep increasing the burden on the exchequer, impede financial intermediation and an efficient allocation of resources, and hamper growth.