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Mains Articles

Bank Nationalization in India: A poignant anniversary [Mains Article]

Despite the great record of Indian banking system, the macroeconomic policies of successive governments have hardly been supportive of a banking structure.
By IT's Mains Articles Team
August 09, 2019

Contents

  • Introduction
  • Banking Scenario during 1950s
  • Multi-agency approach
  • Impact of Nationalisation of Banks
  • Recommendations of Narasimham Committee (1991) and its impact
  • Steps taken to address the unfavorable consequences
  • Role of Public Banks in fulfilling financial inclusion goals
  • Conclusion
  • IT’s Input
    • Nationalization of Banks
    • Liberalisation, Privatisation and Globalisation (LPG) model

Bank Nationalization in India: A poignant anniversary

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Introduction:

nationalized-banks-in-india IASToppers

  • The nationalisation of banks was a turning point in the history of Indian banking system.
  • In July 1969, 14 private banks were nationalised and another six private banks were nationalised in 1980.
  • Such type of transformational change in the banking policy of any country had not happened in history.

Banking Scenario during 1950s:

  • At the time of Independence, India’s rural financial system was marked by the domination of landlords, traders and moneylenders (non-institutional sources).
  • In 1951, a rural household has to take more than 90% loan from non-institutional sources.
  • From the 1950s, there were efforts made to expand the reach of the institutional sector (SBI Group, RBI, etc.), particularly in the rural areas.
  • Despite these measures, the private banking system failed to meet the credit needs of the rural areas.

Multi-agency approach:

  • India’s banking policy after 1969 followed a multi-agency approach towards expanding the geographical reach of the formal banking system.

New branch licensing policy:

  • In this, banks were told that for every branch they opened in a metropolitan or port area, four new branches had to be opened in unbanked rural areas.
  • As a result, the number of rural bank branches increased from 1,833 (in 1969) to 35,206 (in 1991).

Priority-sector lending:

  • In this, all banks had to compulsorily set aside 40% of their net bank credit for agriculture, micro and small enterprises, housing, education and “weaker” sections.

Differential interest rate scheme:

  • Here, loans were provided at a low interest rate to the weakest among the weakest sections of the society.

Lead Bank scheme

  • In this, each district was assigned to one bank where lead bank acted as leader in providing integrated banking facilities to the banks of that district.
  • A bank having a relatively large network of branches in the rural areas of a given district and endowed with adequate financial resources has generally been entrusted with the lead responsibility for that district.

Regional Rural Banks (RRB)

Regional_Rural_Banks IASToppers

  • These banks were established in 1975 to enlarge the supply of institutional credit to the rural areas. the

National Bank for Agriculture and Rural Development (NABARD)

(NABARD) IASToppers

  • It was constituted in 1982 to regulate and supervise the functions of cooperative banks and RRBs.

Overall Impact:

  • Due to the multi-agency approach, the share of institutional sources in the outstanding debt of rural households increased from just 16.9% in 1962 to 64% in 1992.

Impact of Nationalisation of Banks

Positive impact

India’s nationalisation led to a growth of financial intermediation.

  • The share of bank deposits to GDP rose from 13% in 1969 to 38% in 1991.
  • The gross savings rate rose from 13% in 1969 to 22% in 1990.
  • The share of advances to GDP rose from 10% in 1969 to 25% in 1991.
  • The gross investment rate rose from 14% in 1969 to 24% in 1990.
  • India’s nationalisation shows that monetary policy, banks and interest rates can be effectively used to take banks to rural areas, backward regions and under-served sectors.

Recommendations of Narasimham Committee (1991) and its impact:

Recommendations

narsimham-committee-recommendations-and-financial-reforms-7-638

  • The Narasimham Committee of 1991 recommended that monetary policy should not be associated with the redistribution of wealth (specifically in rural areas by means of monetary policies).
  • Instead, the committee suggested that banks should be free to practice commercial modes of operation with profitability as the primary goal.
  • Hence, the Reserve Bank of India allowed banks to open and close branches as they desired.
  • Priority sector guidelines were diluted and banks were allowed to lend loans to activities that were remotely connected with agriculture or to big corporates in agri-business.
  • Interest rate regulations on priority sector advances were also removed.

Adverse Impact:

  • More than 900 rural bank branches closed down across India.
  • The rate of growth of agricultural credit fell sharply from around 7% per annum in the 1980s to about 2% per annum in the 1990s.
  • Between 1991 and 2002, the share of institutional sources in the total outstanding debt of rural households fell from 64% to 57.1%.
  • The space vacated by institutional sources was promptly occupied by moneylenders and other non-institutional sources again.

Steps taken to address the unfavorable consequences

RBI-IASToppers

  • In 2005, the RBI announced a new branch authorization policy.
  • Under this policy, Permission for new branches were given only if the RBI was satisfied that the banks concerned had a plan to adequately serve underbanked areas and ensure actual credit flow to agriculture.
  • By 2011, the RBI further tightened this procedure and mandated that at least 25% of new branches were to be compulsorily located in unbanked centres.

Impact:

  • The number of rural bank branches rose from 30,000 in 2005 to 34,000 in 2011 and 48,000 in 2015.
  • The annual growth rate of real agricultural credit rose from about 2% in the 1990s to about 18% between 2001 and 2015.
  • However, much of agricultural loans were not given to farmers but to big agri-business firms and corporate houses located in urban and metropolitan centers.
  • Hence, the share of institutional loan in the debt outstanding of rural households in 2013 stood at 56%, which was still lower than the levels of 1991 and 2002.
  • In other words, the farmers were not given loans for agricultural development, as a result, they have to take loan from non-institutional sources decreasing the share of institutional loan amount in their total debt.
  • However, the expansion of public bank branches played a vital role in achieving the high growth of loan provision across India.

Role of Public Banks in fulfilling financial inclusion goals

  • After 2005, public banks played a central role in furthering the financial inclusion of successive governments.
  • Between 2010 and 2016, the key responsibility of opening no-frills accounts (a bank account that can be opened and maintained with zero balance) for the unbanked poor were given to the public banks.
  • More than 90% of the new no-frills accounts were opened in public banks which shows the decisive presence and intervention of public banks.
  • The public banks were also acted as vanguard during the global financial crisis of 2007 when most markets in the world, dominated by private banks, collapsed.

Conclusion:

  • Despite the great record of Indian banking system, the macroeconomic policies of successive governments have hardly been supportive of a banking structure.
  • In times of slow growth, the excess liquidity (more money in banking system than needed) in banks was seen as a substitute for counter-cyclical fiscal policy (strategy by the government to counter sudden growth or recession through fiscal measures.)
  • Successive governments, due to fear of higher fiscal deficits, encouraged public banks to lend more for retail and personal loans, high-risk infrastructural sectors and vehicle loans.
  • Here, banks funded by short-term deposit liabilities were taking on exposures that involved long-term risks. Hence, many loans could not be returned to the banks.
  • Consequently, banks are in crisis with rising non-performing assets. The same fear of fiscal deficits is also scaring the government away from recapitalizing banks.
  • The solution put forward is the privatization of banks.

IT’s Input

Nationalization of Banks

nationalization_of_banks IASToppers Bank Nationalization in India: A poignant anniversary

  • Nationalization refers to private assets being transferred to the public sector to be operated by or owned by the state.
  • The Government of India issued the Banking Companies (Acquisition and Transfer of Undertakings) Ordinance, 1969 and nationalised the 14 largest commercial banks.

Reason for Nationalization of Commercial Banks

  • Control of huge resources: The taking over of commercial banks would enable government to have control over huge resources by which it can start large scale industries.
  • Attention to priority sector: The private sector banks were not giving importance to agriculture, small scale industries, cottage industries, and rural industries. With the nationalization of commercial banks, agriculture and its allied industries could be effectively attended.
  • Development of backward areas: The private sector banks were neglecting rural areas and backward areas by concentrating only in urban areas. This trend could be changed by nationalizing these banks and opening their branches in rural and backward areas.
  • Efficiency argument: With more banks in the public sector, modernization could be introduced and efficiency of the banks could be improved. A better recruitment policy could be adopted by which efficient men/women can be employed. Efficient operations will improve banking services and will earn more profit.
  • Profitability: Higher revenue could be achieved and the entire profits earned by these banks will be enjoyed by the government. This helps the government in capital formation.
  • Uniform banking policy: Throughout the country, the banking operations could be uniform and the interest rates prevailing in the banks will also be uniform. Banks will grant loans based on productivity of the borrower rather than the security of the borrower.
  • Mobilization of savings and prevention of money lenders: In the absence of proper banking facility, the public are being exploited by private financiers by offering attractive interest rates. This can be prevented if banks can convince people and provide a reasonable rate of interest. Apart from this, the interest earned from these banks are exempted from income-tax to a certain extent.
  • Encouraging banking habits and creating banking habitat: With increasing literacy in rural areas, the rural people will be made to realize the importance of banking habit. Also, the location of banks will form part of their habitat.
  • Speedy transfer of funds: When more people cultivate banking habits, more transactions in the country will be done with bank money. The need for currency or hard cash will slowly decline. Unaccounted transactions and the generation of black money could be eliminated. Funds can be easily transferred from one place to another by the use of electronic media.
  • Augmentation of Employment: There will be more employment opportunities created in these banks with opening of more branches. Apart from this, the bank can also create more employment opportunities by encouraging self-employment activities.

Liberalisation, Privatisation and Globalisation (LPG) model

  • In 1991, India met with an economic crisis relating to its external debt as the government was not able to make repayments on its borrowings from abroad.
  • Foreign exchange reserves dropped to levels that were not sufficient for even a fortnight. The crisis was further compounded by rising prices of essential goods. All these led the government to introduce a new set of policy measures.
  • The then Prime Minister of India initiated economic reforms under a committee chaired by P V Narasimha Rao.
  • The government, as per the recommendation of committee, announced a New Economic Policy in 1991 which is commonly known as the LPG or Liberalisation, Privatisation and Globalisation model.

Liberalisation:

Liberalisation refers to end of license, quota and many more restrictions, which were put on industries before 1991. Indian companies got liberalisation in the following way:

  • Abolition of licence except in few.
  • No restriction on expansion or contraction of business activities.
  • Freedom in fixing prices.
  • Liberalisation in import and export.
  • Easy and simplifying the procedure to attract foreign capital in India.
  • Freedom in movement of goods and services
  • Freedom in fixing the prices of goods and services.

Privatisation:

Privatisation refers to giving greater role to private sector and reducing the role of public sector. To execute policy of privatisation government took the following steps:

  • Disinvestment of public sector, i.e., transfer of public sector enterprise to private sector
  • Setting up of Board of Industrial and Financial Reconstruction (BIFR). This board was set up to revive sick units in public sector enterprises suffering loss.
  • Dilution of Stake of the Government. If in the process of disinvestments private sector acquires more than 51% shares then it results in transfer of ownership and management to the private sector.

Globalisation:

It refers to integration of various economies of world. Till 1991, Indian government was following strict policy in regard to import and foreign investment in regard to licensing of imports, tariff, restrictions, etc. but after new policy government adopted policy of globalisation by taking following measures:

  • Import Liberalisation. Government removed many restrictions from import of capital goods.
  • Foreign Exchange Regulation Act (FERA) was replaced by Foreign Exchange Management Act (FEMA)
  • Rationalisation of Tariff structure
  • Abolition of Export duty.
  • Reduction of Import duty.

Liberalisation

Positive Impact

  • Increase in foreign investment
  • Increase in Production
  • Technological advancement
  • Increase in GDP growth rate

Negative Impact

  • Increase in Unemployment
  • Decrease in Tax Receipt

Privatisation

Positive Impact

  • Private companies cut cost and be more efficient
  • Increased competition
  • More Responsive to customer complaints

Negative Impact

  • Job loses
  • Privatisation is expensive

Globalization:

Positive Impact

  • Expansion of market
  • Development of infrastructure
  • Higher living standards
  • International cooperation

Negative Impact

  • Cut throat competitions
  • Rise in Monopoly
  • Takeover of Domestic Firms
  • Increase in Inequalities

 

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