When the US government’s takeover of Citibank is one of the options being considered for salvaging that once proud institution, it is understandable that Sonia Gandhi should see virtue in Indira Gandhi’s nationalisation of 14 banks in 1969. Since banking is an area of delayed reform, it is worth examining the issue—in its context, and whether it has served intended and unintended purposes.
First off, the decision had little to do with economics. Indira Gandhi was in a fight with her own party bosses, her challenger in the Cabinetfinance (Morarji Desai) was minister, and she upstaged him first by taking away his portfolio (forcing him to resign) and then announcing the nationalisation. Among the thoughts then were that, since the banks’ resources would now be available to the government, it might be possible to abolish the income tax! The country still waits for such happy tidings, but the move served its purpose because Mrs Gandhi was able to seize the initiative, split the Congress, keep her minority government going with the support of the Communists, and then sweep the elections announced a year ahead of schedule, in 1971. Given this history, no one should expect the Congress to undo bank nationalisation.
Economic justification for the nationalisation followed, in a new thrust to bank functioning: rural branch expansion, and credit for hitherto under-banked sections (small industry, transport operators, farmers, etc). So it is not that there were no beneficial results. Indeed, economists have argued that deeper bank penetration into the countryside led to an increase in financial savings which, a decade later, manifested itself in a jump in the economic growth rate (from 3.5 per cent till then to 5.5 per cent). Another positive consequence was that the nexus between industrial and financial capital was broken, because it was the big business houses that had owned all or most of the banks (Tata had Bank of India, Birla had United Commercial Bank, Dalmia-Jain had Punjab National Bank, and so on). This helped create a more level playing field for new entrepreneurs to emerge—one of the strengths of the economic system today.
There were negative consequences too. Banks’ functioning became politicised, Reserve Bank control gave way on many issues to ministerial prerogative and interference, rampant unionisation prevented computerisation and caused over-manning and poor customer service, and there was widespread corruption in granting loans. Bank balance sheets became suspect as the focus had moved away from profitability, credit recovery and other basic banking concepts. It was only after the economic reforms began that proper financial discipline was introduced, with tighter provisioning norms, proper capital adequacy, and the like. And the state-owned banks focused on customer service only after being challenged by new private sector players.
The real failure of the state-owned banks has been in management—as demonstrated by the superior track record of the private banks, both foreign and Indian. When Citibank introduced automated teller machines in the country in the 1980s, the then chairman of State Bank of India declared that such new-fangled gadgets had no relevance in India! Since then, the state-owned banks have been playing catch-up on virtually every front. The share of the state-owned banks in total banking business has declined steadily as a consequence, dropping to 70 per cent, and would be much lower if the Reserve Bank did not hold back the private sector horses. So, don’t expect de-nationalisation, which the politicians will continue to defend; wait instead for a repeat of what has happened in aviation, where the former state-owned monopolist (the merged Air-India) now has 18 per cent of the market.