India: A Sad Anniversary - 50 Years of Bank Nationalisation

Jan 2019
India, January, 07 2019 - It’s been 50 years since bank nationalisation and it would have made more sense to provide private commercial banks incentives to open rural branches rather than nationalise them.

The year 2019 marks the 50th anniversary of bank nationalisation. If one had to select one policy that has been most ruinous to the Indian economy and Indian politics together, the prize undoubtedly goes to bank nationalisation. When she made the decision, Indira Gandhi told IG Patel, then the top civil servant in the ministry of finance, that it had been decided for political reasons to nationalise the leading commercial banks. The goal was to upset Morarji Desai, the finance minister who would never have approved had Indira Gandhi consulted him. The kitchen cabinet was more powerful than the real one!

The move had the desired political effect and Indira Gandhi split the Congress Party. The public was told that bank nationalisation was for the purpose of extending bank facilities to rural areas, what we would now call financial inclusion. Given that the issue of financial inclusion was not really tackled till after the turn of the century, and has only been solved in the last decade with Jan Dhan accounts, the failure of nationalisation is obvious. In any case, it would have made more sense to provide private commercial banks incentives to open rural branches rather than nationalise them.

The real,purpose—Indira was no slouch when it came to consolidating power—was that it gave the ruling party access to finance as and when it needed without having to resort to black money (though that was extracted from businessmen as well). One chairman of a PSU bank, now happily retired, told me that he would regularly get orders (not requests) to give loans to such and such constituency—Congress of course—to implement a development scheme. He said they knew the money would never be repaid. It had to be written off as bad debt. Another director of a PSU bank separately confirmed that story saying you just had a call stating the amount and the name of the beneficiary. Good bye to another Rs 100 crore!

This then fructified into the NPA disaster during UPA-II, as is now well known. Projects which had been given crores with the high reputation of corporate borrowers stalled. The borrowers knew that the mechanism for the lender to recover loans was clumsy, time consuming and loaded in the debtors’ favour. It was a bonanza for the crony capitalists and no doubt the powerful at the top who must have collected their cut.

It has taken the BJP/NDA a long time to get on top of this mess. The best thing the Modi government has done is to reform the insolvency procedure so the lender can seize the assets of the defaulters or force a sale. This has stopped the cowboy behaviour of the cronies.

The restructuring of the PSU banks has mostly concentrated on mergers and consolidation. The abysmal management which let the bad loans build up has not been replaced nor has it been held up for failure of due diligence and criminal neglect. If these banks had been in the private sector, they would have been declared bankrupt and shut down or been taken over. As it is, the poor taxpayer has to throw good money after bad. The government has taken the cautious route of recapitalising these bad banks rather than shutting them down or privatising them. Even giving them away (as I would recommend in the case of Air India) would save the taxpayer precious money.

Despite the good hard work, the government will get no political advantage. Congress, which lit the fire of bad loans, is now blaming the BJP for loan write-offs. The Herculean effort to clean up the Augean stables of nationalised banks is too complex to win votes. Its benefits in terms of bank liquidity and availability of credit will benefit the country only in the longer run.

It is most likely that the BJP/NDA will be back after the election. It is a chance for Modi and Jaitley to pursue radical reforms. The consolidation process should be completed covering all PSU banks. Then there should be serious efforts at divestment. There is no credible justification for having retail deposit banks in government ownership. For nostalgic reasons, the State Bank, in its new consolidated form, could be kept in the public domain. But cast the rest away, give the taxpayer a break and break the hold of the crony capitalist friends of the ancient regime on the banking system. A whole new younger and smarter generation of entrepreneurs will bring real economic success to India if they can compete for credit on a level playing field. Hire new, internationally credible managers. Sack the existing ones. You don’t have to send them all to jail.


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