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Introduction:
On July 19, 1969, Indira Gandhi who was both Prime Minister and Finance Minister at that time decided to nationalize 14 largest private banks of the country. The reason for nationalizing banks was to sync the banking sector with the goals of socialism adopted by the Indian government after independence.
Factors and reasons that led to nationalisation of banks
- Lesser lending to rural areas: Even though the banks lent credit, the disbursal to the rural areas and small scale borrowers was far less as compared to the industry despite the Banking Regulation Act, 1949.
- Agriculture credit neglected: The loans by commercial banks to industry nearly doubled between 1951-1968 from 34 to 68 per cent, even as the agriculture received less than 2 per cent. The government of the time believed that the banks failed to support its socio-economic objectives and hence, it should increase its control over them.
- Expansion of banking: The idea was to ensure reach of bank to unserved and underserved areas, especially remote hinterland. This would result in formalising the economy to an extent.
- Mobilization of savings: Nationalisation aimed at mobilizing the savings of the people to the largest possible extent and to utilize them for productive purposes.
- Economic and Political reasons: Bank nationalization was one of Indira Gandhi’s responses to the economic and political challenges of the time.
- For example, there were two wars—with China in 1962 and Pakistan in 1965—that put immense pressure on public finances .
- Two successive years of drought had not only led to food shortages, but also compromised national security.
- The main objective was to Reduce regional imbalance and increase Priority Sector Lending.
Impact on economic development and job creation
- Increase in Savings: Financial savings rose as lenders opened new branches in areas that were unbanked. Gross domestic savings almost doubled as a percentage of national income in the 1970s.
- Improve in bank efficiency: Due to the nationalization of banks, the efficiency of the banking system in India improved. This also boosted the confidence of the public in banks.
- Small scale industries boost: The sectors that were lagging behind like small-scale industries and agriculture got a boost. This led to an increase in funds and thus increases in the economic growth of India.
- Penetration of banks: The nationalization of banks also increased the penetration of banks. This was mainly seen in the rural areas of India.
- Financial inclusion: India’s nationalisation led to an impressive 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 12.8% in 1969 to 21.7% in 1990.
- The share of advances to GDP rose from 10% in 1969 to 25% in 1991. The gross investment rate rose from 13.9% in 1969 to 24.1% in 1990.
- Nationalisation also demonstrated the utility of monetary policy in furthering redistributionist goals.
- Outreach increased: Banks were no longer confined to only metropolitan or cosmopolitan in India. In fact, the Indian banking system has reached even to the remote corners of the country.
- Green Revolution: This is one of the main reasons for India’s growth process, particularly in the Green revolution. It led to increased food security in India, reducing dependence on food grain imports.
Negative impact of nationalisation of banks
- Bad loans: After nationalization, some banks were operating under losses .This is because banks advance loan without adequate security. The recovery of loan was poor which lead to losses.
- Inefficiency: Due to the nationalisation of banks, there was a bureaucratic attitude in the banking sector. There was no responsibility, accountability or incentive for it to progress within the public sector banks. Unwarranted delays were the new norm within these banks.
- Long-term risks: Though liberal credit is necessary for the development of rural India; it had also created harmful effects on the stability of the banking sector. The nationalised banks are now facing the problems of overdue loans and the establishment of economically unviable branches.
- Political Interference: Another limitation of nationalized commercial banks was increasing the political interference in granting loans, appointment of banks personnel, opening of new branches etc.
- Inadequate Facilities: Nationalized commercial banks have failed to provide adequate facilities and services to population living in rural and sub urban area. Banks failed to mobilize rural deposit.
Although the government had succeeded in partially meeting its goal of implementing its developmental agenda through the banking sector, many in India did not reap the benefits intended by the nationalisation of banks.
Conclusion
Bank nationalization was the pivot of a broader political economy strategy followed in the 1970s—a decade when economic growth barely outpaced population growth and average incomes stagnated. It was a lost decade for India. There is no doubt that exogenous shocks, such as rising energy prices or failed monsoons, played a part in the stagnation, but economic policy also hurt. Bank nationalization succeeded in specific areas such as financial deepening because of the rapid spread of branches, but it now needs a rethink.
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