Bank nationalization: blunder or masterstroke?

GS Paper 3

Program: Effects of liberalization on the economy (changes after 1991)

Source: Indian Express

The context: 53rd anniversary of the nationalization of 14 banks by Prime Minister Indira Gandhi. The government will provide legislative changes to the current session of Parliament to enable it to privatize the PSOs (denationalization of banks).

  • This item should be ready only from Sector point of view.

Nationalization is the process by which the government of a country or state takes control of a specific business or industry. The post-1967 period saw a series of radical economic policies such as the nationalization of the 14 largest commercial banks (1969), Insurance (1972), coal industry (1973), an effort to nationalize wholesale wheat trade (1973), the revival of “sick” companiesetc

  • According to many economists, the long-term impact of these decisions is being felt today, in the form of a looming banking crisis, an inefficient coal sector and low insurance penetration (3.76% in 2019; one of the lowest in the world).

Objective of the 1969 banking nationalization: The government aimed to take control away from a few private actors and extending banking coverage to rural India so that sectors such as agriculture and small industries could obtain better credit facilities, thus creating a new class of entrepreneurs.

The nationalization of the 1970s was a bad decision because it led to:

  • The emergence of structural characteristics that engendered inefficiency: The Nationalization Strategy Associated with Import Substitution Industrialization (ISI) and the “Licence Quota Raj” entrepreneurship and innovation stifled.
    • Nationalization reduced competition between the public sector and the private sector, this again led to the bureaucratic attitude in the operation of UAPs, Lack of initiative and responsibility, populist pressures, irresponsible unionism, red-tapism, etc.
  • India has lost “internationalization of production”:
    • India’s Policy of Nationalization and Inward-Looking ‘Protectionist’ Economy have failed to take advantage of the globalization that has created miracle economies in East Asia.
    • This implied that India’s exports had fallen by 2.4% (1948) at 0.42 in 1980.
  • Erosion of fiscal prudence: Public spending continued to rise due to the proliferation of subsidies and handouts, wage increases unrelated to efficiency or production, overstaffing, and other “populist measures”.
    • Because of thelack of performance audit, financing of public banks and PSUs failed to achieve high public interest
  • Current impact:
    • The NPA crisis is seen as the legacy of the nationalization of banks in the 1970s and 1980s: Government ownership and political interference reduced bank liability and all twelve Public Sector Banks (PSBs) recorded gross NPAs worth Rs 5.47 lakh croremore than double the NPA of 19 private banks in 2020.
      • In addition, nationalized banks are either operating at a loss or experiencing declining dividends.
    • The insurance sector is facing low penetration issues (only 3.76% overall insurance penetration in India), public sector monopoly, low non-life insurance rate (less than 1%) and poor financial health of public sector insurers.
    • The government has still not been able to close all the Nationalized “sick” PSUsdraining taxpayers’ money.
  • Report of the Nayak Committee (2014): Public sector banks have poor financial condition, compromised and non-transparent selection process, high NPAs, weak board governance.
  • Review of the Economic Survey of Nationalization of Banks (2020): Every rupee of taxpayers’ money invested in PSOs yields a market value of just 71 paise (on the other hand private sector banks recover a market value of Rs 3.70)
  • “Bank phone” problem: Officials of public sector banks may be forced to provide loans when such loans do not make economic sense.
  • Economic study 2020 stressed that PSOs appreciate less strategic and operational freedom due to majority state ownership.

However, nationalization helped the Indian economy as it led to:

  • Increased penetration of the banking sector in rural areas and underdeveloped sectors: from just 8,262 bank branches (1969), the number grew to 30,303 in 1979.
    • Availability of liberal credit by banks led to India’s growth process, especially during the green revolution.
    • Credit to rural areas increased from Rs 115 crore to Rs 3,000 crorea multiplied by twenty.
    • Mobilization of deposits in rural banks and rural credit increased considerably after nationalization in 1969
  • Loans to priority sectors:e. earmark 40% of banks’ net bank credit for agriculture, micro and small enterprises, education, housing and “weaker” sections.
  • Domestic savings: Domestic savings and investment rates increased rapidly from 10% in the 1950s to 20% in the 1980s.
  • Removal of private sector monopoly in certain sectors such as coal: After the nationalization of the coal industry in India, India never experienced a gap between supply and demand until 1991
  • Investment in government securities: In recent years, bank investments in government securities and other approved securities have increased significantly.
  • The balance of payments situation has improved considerably after nationalization, as the green revolution led to a reduction in food and other imports. In 1978-79, foreign exchange reserves peaked at about $7.3 billion.
  • Increasing job opportunities: The huge expansion of PSUs has created employment opportunities, giving employment to a large number of educated young people in the country.
  • Success of “JAM Trinity”: JAM stands for Jan-Dhan, Aadhaar and mobile number.
    • The initiative would have been a not leaving if there had been only private banks and no PSB in the country.
    • of total 46 crore beneficiaries, only 1.3 crore have accounts in private sector banks – that’s just 2.82%.

So, conceptually, nationalization was a good idea because it pushed for the redistribution of wealth, job creation and financial inclusion. However, efforts should have been made to improve efficiency and make UAPs competitive as China has done.

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Nationalization of banks

Practical matters

Q. What were the factors that led to the nationalization of the banks? Examine its impact on economic development and job creation. (15M)

Consider the following statements: (UPSC 2019)

1.The coal sector was nationalized by the Indian government under Indira Gandhi.

2.Now coal blocks are awarded based on lottery

3. Until recently, India imported coal to meet domestic supply shortages, but now India is self-sufficient in coal production.

Which of the above statements is/are correct?

(a) 1 only

(b) 2 and 3 only

(c) 3 only

(d) 1, 2 and 3

Respond to

Statements 2 and 3 are incorrect. Coal is auctioned and India still imports coal (especially coking coal)

The fundamental objective of the Lead Bank Scheme is that (UPSC 2012)

(a) big banks should try to open offices in every district

(b) there should be fierce competition between the various nationalized banks

(c) individual banks should adopt particular quarters for intensive development

(d) all banks should make intensive efforts to mobilize deposits

Answer: C

The Lead Bank Scheme, introduced in 1969, considering assigning lead roles to individual banks for their assigned districts.

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