When Nationalization Changed the Face of Indian Banking – From Class to Mass

The banking system is the engine of any economy, and the rise and fall of any economy largely depends on the health of its financial sector.

About 53 years ago, on July 19, 1969, the then government nationalized the 14 largest private commercial banks in the country through the Banking Companies (Acquisition and Transfer of Businesses) Ordinance 1969 and decided to hold more than 50% of the capital.

The impact of this decision would be greater than the economic reforms of 1991 in certain areas. Similarly, in the second phase, on April 15, 1980, the then government nationalized six more private banks with a capital of Rs 200 crore.

After independence, the Indian government adopted the socialist path with India’s first five-year plan in 1951, which required significant support from the banking sector to complete.

Many countries suffered heavy financial losses in the aftermath of World War II. Many European countries nationalized their banks to overcome the crisis. India has also been plagued by economic and political shocks. There were wars with China in 1962 and with Pakistan in 1965, which put immense pressure on public finances.

Until 1968, all private banking in India was restricted to major cities only. All were monopolized by the industrialists, the share of industry in the credits granted by the private banks doubling between 1951 and 1968, passing from 34% to 68%, while agriculture received less than 2% of the total credit.

One of the main objectives of the nationalization of banks was the expansion of banking activities in rural areas to ensure financial inclusion. People’s confidence was very low in the banking sector, which was a major impediment to the expansion of the banking sector in India.

The nationalization of banks changed the fate of rural areas. Banks began to move out of cities and open in villages and towns.

In three decades, the number of bank branches in the country increased from 8,000 to 60,000. The share of rural deposits reached 15.5 percent in March 1991, against 6.3 percent in December 1969, and the share of loans increased from 3.3 percent to 15 percent. Banks were asked to direct funds to areas the government wanted to develop.

Nationalization also strengthened the Green Revolution. Its objective was to make the country self-sufficient in food security.

Gross domestic savings almost doubled as a percentage of national income in the 1970s.

At the same time, there was an almost 800% increase in deposits in Indian public sector bank branches and a massive 11,000% increase in advances (loans). The share of small industrial units in total bank credit rose from 6 percent in June 1968 to 12 percent in June 1973. Steady increases were recorded in the share of rural areas in total credit and deposits.

However, the nationalization of banks has also received its share of criticism from time to time, and the government at the time is said to have taken this step for political gain.

It is also true that nationalization has led to a decline in the efficiency and profitability of banks.

Simultaneously, lack of accountability and initiative, bureaucracy and excessive delays became common features of nationalized banks.

The nationalization of banks has reduced competition between banks to a large extent. At the same time, it dramatically increased political interference and bureaucracy in the operation of the banking system.

Banks have been hijacked for political purposes. It has also exacerbated the problem of non-performing assets (NPA), with scams becoming common in public sector banks. These banks are now grappling with the problems of huge overdue loans and financially unsustainable branches.

The current government is emphasizing the privatization of banks, but it is not hiding from anyone the performance of banks in the private and public sectors in times of crisis, including the covid-19 pandemic.

The government should not rush the privatization of banks; rather, it should focus on comprehensive governance reforms, because if the banking sector is run by independent boards in a dynamic way, public sector banks can also operate like any other private bank.

Nationalization transformed the bank from a “class bank” to a “mass bank” (social bank).

The author is Associate Professor, Jawaharlal Nehru University

(Disclaimer: The opinions expressed are those of the author and Outlook money does not necessarily subscribe to it. Outlook money will not be responsible for any damage caused to any person/organization directly or indirectly.)

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