Revising History – Banks’ Nationalization

Nationalization of 14 banks fifty years ago has been termed as the most defining economic event by RBI; even bigger than the reforms of 1991. The event, although, had political developments of that time as trigger, did lead to complete re-orientation of Indian Banking. Here is a look at the background and the changes that the decision achieved.

India’s banking sector witnessed an upheaval in July 1969 when 14 large banks (out of over 90 commercial banks, then) above a threshold size (having deposits not less than Rs 50 crore) were nationalized. While this is popularly known as nationalization of banks, this was not the first decision towards that. Nationalization had actually started in 1955 when the then largest bank, Imperial Bank, was taken over by the government and renamed State Bank of India (SBI). This was followed by nationalization of banks owned by princely states in 1959 which were made subsidiaries of SBI (hence the name State Bank of Patiala etc).

The decision also has a political connotation notably, to establish the position of the then Prime Minister, Mrs Indira Gandhi. This is also echoed by the fact that it was carried out through an ordinance (and was ratified by the Parliament only afterwards). Yet, that was, at best, a secondary objective. The exercise was repeated again in 1980, after Mrs Gandhi came back to power, nationalizing six more banks meeting the cut-off criteria. However, banks alone were not under the radar of the government. Even large insurance as well as coal-mining companies were nationalized in 1970s. Indeed, the nation took a ‘Socialist’ turn with the insertion of the word in preamble in 1976.

The backdrop of the event was the fact that privately owned commercial banks had failed in the core objective of banking i.e. financial intermediation – mobilizing resources from the savers and lending it to the sectors aligned with national objectives. Some figures lend credence to the rationale. As per RBI database, gross domestic savings as a percent of GDP stood at 12% in 1968-69, just before the nationalization, which rose to 21% by 1978-79. (The next wave of growth in domestic savings and investment started around 2005).

Low savings rate had its genesis in low banking penetration. As per an RBI document titled ‘History of RBI’, out of 600,000 villages in India at that time, only about 5,000 had banks. Not only villages, even coverage of towns was low at about 25% only. The other side of the coin was the skewed nature of credit distribution. As per RBI’s history, metropolitan cities got the maximum benefits with credit received by them being 106% of their deposits against less than 40% for rural area. The ratio changed to 84% and 59% by 1981. (The ratio can be maximum around 70% on aggregate basis after meeting statutory norms). (The ratio can be maximum around 70% on aggregate basis after meeting statutory norms).

So, who was gaining from this? A committee of economists’ set-up then made some insightful observations. The report stated that credit was being appropriated by few large industrial houses leading to growth of monopolies and concentration of economic powers. And this was being done through direct/indirect influence of the industrial houses on banks’ operations. As per the report, close to 200 directors of 20 leading banks held directorship in 1,100 other operating companies, a clear case of ‘conflict of interest’. Close analysis of five leading banks showed directors of these banks were connected to over 600 manufacturing, trading and other companies. (The policy separating banking from other businesses, imitated around then, has become more stringent over the years).

However, this alone was not the reason for the momentous step. A bigger reason was enabling credit to agriculture sector and kick-starting India’s green revolution which had witnessed two famines around this time. As a result of nationalization, share of loan by scheduled commercial banks to agriculture sector rose from barely 14% in 1971-72 t0 41% ten years later and further to 58% by 1990-91. (RBI, possibly, did not maintain separate data for loan to agriculture before nationalization). SCBs continue to be the dominant force in rural financing even now accounting for over 72% of rural financing. Share of banking (together with insurance) in GDP has risen from 1.7% in 1969-70 to 3% in ten years and now stands close to 6%.

A pertinent question that comes up is, did nationalization help meet national objectives? No doubt, as figures mentioned above show the decision changed the entire landscape leading to ‘inclusive’ banking. While this also, possibly, led to inefficiency, it was certainly a lesser evil than what the nation grappled with before nationalization.

(Image Source  – RBI’s Website)

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