The economic rationale of bank nationalisation


Before the government concludes its discussions with the Reserve Bank of India (RBI) on privatising public sector banks (PSBs), it may want to study the history of Indira Gandhi’s bank nationalisation — for nationalisation did have its positive outcomes and privatisation can have negative outcomes.

It’s not surprising that the nationalisation of 14 banks in 1969 has generally been seen as a politically-motivated decision. At the time, PN Haksar was secretary in the prime minister’s secretariat. He was, in the words of his biographer Jairam Ramesh, “Indira Gandhi’s ideological compass and moral beacon”. She was then fighting a running battle with the Syndicate, a group of veteran leaders who had earlier chosen her to be prime minister, and with her rival, Morarji Desai.

Haksar, a former communist, advised her to convert this from a personal to an ideological battle, projecting an image of Gandhi, the progressive, being challenged by reactionaries. Bank nationalisation has been seen as the first major step in this political conversion and its economic justification has been ignored.

The pre-nationalised banks had a profit motive, and shared close links with the corporate sector. So it’s not surprising that they had been lending 67% of their funds to industry and virtually nothing to agriculture. In 1969, commercial banks couldn’t lend money to farmers because they were only present in less than 1% of villages. Farmers were unable to get bank loans just when the Green Revolution was getting underway and they needed credit to buy the expensive inputs required to increase output.

In 2018, it was estimated that four out of five Indians had a bank account. Had the banks not been nationalised, I don’t think they would have ventured so deeply into unprofitable rural India. But if PSBs are now widely present in the countryside, why have they not been more effective in providing credit to farmers? Why are indebted farmers still dying by suicide? Why are money lenders still able to find borrowers prepared to pay 5% interest per month on a loan?

The bureaucratic functioning of banks has been a serious impediment to farmers getting timely loans. Some years ago, in the Karnataka town of Navalgund, a bank manager told me that a farmer had to get certificates that he was free of debt from the nine other banks operating in the town before applying for a loan. As manager, he had to check and sign every transaction. That could involve a thousand signatures a day. When I asked why he alone could sign, he replied: “I have two other officers classified as supervisory but under bank rules, they are not allowed to supervise.”

Because PSBs are owned by the government, politicians in power think they are the owners. This has led to two frequent forms of political interference in banking. The first is known as telephone banking, with politicians ringing bank officials with instructions to lend money to their cronies. Second, some politicians have also undermined PSB’s by using them to win votes with loan waivers or by responding to public demand to finance unproductive projects. But it is a myth that PSBs are inherently inefficient, and privatisation is more efficient. If this is not challenged, banking reforms currently being discussed may well cause an imbalance in India’s development even further.

If the corporate sector is allowed to dominate banking again, profit will become the prime motive rather than the desire to serve the public.

A better solution than privatisation may well be giving PSBs autonomy to reform themselves and function free of political interference. Remember, most East Asian success stories have been underpinned by financial systems effectively controlled by governments, and in the West, governments have had to rescue private banks from bankruptcy. India should think through its approach to public banks.

The views expressed are personal


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