In this project report we will discuss about:- 1. Introduction to the Nationalisation of Commercial Banks 2. Justification for the Nationalisation of Commercial Banks 3. Objectives 4. Critical Appraisal.
Introduction to the Nationalisation of Commercial Banks:
Prior to 1949, commercial banks in India were exclusively owned, controlled and managed by private entrepreneurs and shareholders. The process of nationalisation of banks began when the Reserve Bank of India was nationalised on 1 January, 1949 with the passing of the Reserve Bank (Transfer of Public Ownership) Act, 1948.
It was essential to nationalize the RBI as the central bank of the country in order to ensure greater coordination of monetary, economic and fiscal policies in independent India which was to embark itself on the path to planned economic development.
But the first step towards the nationalisation of commercial banks was taken with the nationalisation of the Imperial Bank of India as the State Bank of India on 1 July, 1955. The second step was taken when 7 State-associated banks were nationalised as subsidiaries of the State Bank of India in 1959.
These seven associate banks are – the State Bank of Hyderabad, the State Bank of Jaipur and Bikaner, the State Bank of Travancore, the State Bank of Mysore, the State Bank of Patiala, the State Bank of Indore, and the State Bank of Saurashtra.
The third major step was the nationalisation of 14 major commercial banks with deposits exceeding Rs. 50 crores each on 19 July 1969. They are: Allahabad Bank, Bank of Baroda, Bank of India, Bank of Maharashtra, Canara Bank, Central Bank of India, Dena Bank, Indian Bank, Indian Overseas Bank, Punjab National Bank, Syndicate Bank, Union Bank of India, United Bank of India, and United Commercial Bank.
The last step was the nationalisation of 6 more commercial banks on 15 April 1980. They were: Andhra Bank, Corporation Bank, New Bank of India, Oriental Bank of Commerce, Punjab and Sind Bank, and Vijaya Bank. At the time of nationalisation, each one of these had crossed the deposit mark of Rs.200 crores, though at the time of nationalisation of 14 banks their individual deposits were below Rs.50 crores.
In June 1996, there were 19 nationalised banks, New Bank of India was merged with Punjab National Bank in 1993. We discuss below the justification, objectives, achievements and failures of nationalisation of commercial banks in India. As nationalisation of major commercial banks is an established fact now, the case against nationalisation is uncalled for and hence of purely academic interest.
Justification for the Nationalisation of Commercial Banks:
The nationalisation of the commercial banks in India was a very controversial issue till the nationalisation of 14 major banks in July, 1969. A number of arguments were advanced by economists, political leaders, bankers, workers, and the public in support of nationalisation of banks which are enumerated below:
1. Neglect of Priority Sectors:
A major charge against banks in India was that they advanced loans to large scale industries, and neglected the priority sectors such as agriculture, small scale industries, etc. The banks advanced 60% of the total bank credit to big industries and 19% to trade in March 1968. On the other hand, the share of agriculture was 2.2%, of small industries 6.9%, and of retail trade less than 2% in the total bank credit. It would be possible to direct bank credit on a large scale through bank nationalisation.
2. Neglect of Plan Priorities:
Another charge was that commercial banks neglected plan priorities and diverted credit into less important channels. Bank nationalisation would help the Government in directing bank credit in accordance with plan priorities.
3. High Profits:
It was alleged, that banks earned huge profits which were disproportionate to the capital invested in the banks. The ratio of profits of scheduled banks before tax to the paid-up capital and reserve increased from 12.2% to 42.5% in 1968. In other words, they earned Rs.42.5crores annually. On the other hand, their capital base was declining. The ratio of paid-up capital and reserves to deposits fell from 9.7% in 1951 to 2.6% in 1968.
This was in contravention of RBI’s directives to banks to keep at least 6% of their deposit liabilities in reserve. Whereas the banks earned huge profits and used them for their interests, the shareholders earned almost nothing because they had hardly more than 1% of deposits as share capital. This was one of the arguments advanced by the Government for bank nationalisation.
4. Funds for Plans:
By nationalising the banks, these huge profits of the banks would be available to the Government for financing plans and achieving the plan objectives.
5. Concentration of Economic Power:
It was alleged that commercial banks had led to the concentration of wealth and economic power in the hands of a few big business houses and industrialists. For instance, the Central Bank of India Ltd. was being controlled by the Tatas, the Bank of India Ltd. by the Mafatlals, the Punjab National Bank Ltd. by the Dalmias, the United Commercial Bank Ltd. by the Birlas, etc. These big business houses, in turn, controlled a number of industries, thereby enjoying a virtual monopoly in their business.
Moreover, about 90% members of the Board of Directors of banks consisted of industrialists and big businessmen. A single director of a bank was a common director of many other industrial concerns and with his control over the bank he was able to turn the bank for the benefit of his industrial house.
This interlocking of directorship in banks led to unusually high amount of credit to big business houses. Bank nationalisation was, therefore, essential to stop the misuse of the resources of the banks for the benefit of directors and their concerns, and to reduce the concentration of economic power and wealth in a few hands.
6. Socialist Arguments:
It was argued that bank nationalisation, was essential for the attainment of a socialist society in India. Such a step would not only reduce concentration of economic power and wealth but also give the State, control over the resources of the banks to be utilised for the masses.
7. Regional Imbalances:
It was alleged that commercial banks were increasing regional imbalances. Banking was concentrated in big cities, urban centres and a few States. The Gadgil Study Group of the National Credit Council (1969) vividly brought out the imbalances in banking in the country.
It pointed out that till December 1967, out of 5,64,000 villages in India, not even 1% were served by commercial banks. In 13 districts of the country, there was not a single commercial bank office. More than 600 towns did not have commercial banking facilities.
There were 63 districts in which per capita credit was less than one rupee, in another 13 districts, credit was not extended even to a single individual, although deposits were mobilised from there. The two metropolitan cities of Mumbai and Kolkata accounted for one-third of total deposits and one-half of total credit disbursed by banks.
The ratio of credit to deposits was more than 100% in the metropolitan cities, which means that deposits mobilised in smaller centres were diverted to these cities for financing the activities of big business. It was argued that bank nationalisation would remove these imbalances, ensure even distribution of banking facilities, and spread banking to rural unbanked and under-banked areas.
8. Ignored RBI Directives:
Big banks with strong financial background often ign6red the Reserve Bank’s directives under the Banking Regulation Act, 1949. This, in turn, adversely affected the RBI’s monetary policy. By nationalising such banks, the RBI would be in an advantageous position to implement its monetary policy more effectively.
9. Protection to Depositors:
It was argued that bank nationalisation would remove the fear of bank failures from the mind of public, thereby protecting the interests of depositors. This, in turn, would inculcate banking habits among the people, especially in the rural non-monetized sector of the economy.
10. Check of Undesirable Activities:
The commercial banks often indulged in anti-social and undesirable activities. They advanced credit for such activities which encouraged speculation, profiteering black marketing etc. which led to accumulation of black money in bank accounts. All such activities would be stopped when banks were nationalised.
11. Encouraged Inflation:
It was alleged that commercial banks encouraged inflation by increasing the supply of money without due regard to the directives of the RBI. Banks often used their resources to the discretion of their directors for their own interest and that of their business friends. So they did not follow the guidelines issued by the RBI for credit restriction. This led to inflation. Thus nationalisation of banks was considered to be the only remedy.
12. Increase in Efficiency:
It was argued that bank nationalisation would improve the efficiency of banks and the quality of service to the customers because the employees would have a greater sense of security. The efficiency of banks would also increase due to the standardisation of banking operations throughout the country.
13. Better Management:
With the nationalisation of banks, the Government would be in a position to develop and provide adequate training and modern managerial techniques to the staff. This would lead to greater efficiency in bank operations.
14. Better Service Conditions:
It was hoped that bank nationalisation would provide better service conditions for the employees. They would have the satisfaction of being Government employees. This would also improve employer-employee relations and pave the way for a smooth working of the banking system in the country.
15. Success in Other Countries:
The protagonists of bank nationalisation argued that in a number of developed and developing countries where commercial banking was in the hands of State, it had been highly successful in helping the masses and mobilising resources for development.
For example, 90% of commercial banking was in the public sector in Italy, 80% in France and 70% in Germany. Among the developing countries, Egypt, Myanmar, Indonesia, and Sri Lanka had been successfully operating nationalised banks.
Out of the above only a few arguments seemed to have weighed with the Government in nationalising 14 major commercial banks on 19 July, 1969 and 6 more commercial banks on 15 April, 1980. This becomes clear from the objectives of bank nationalisation outlined by the Government in the Parliament.
Objectives of Bank Nationalisation:
The Banking Companies (Acquisition and Transfer of Undertakings) Act, 1970 under which 14 banks were nationalised with effect from 19 July, 1969 spelt the main objective as “to serve better the needs of development of the economy in conformity with national policy and objectives and for matters connected therewith or incidental thereto”. The specific objectives which the nationalised banks were expected to pursue were outlined by the then Prime Minister Mrs. Indira Gandhi in her statement to the Parliament on 21 July, 1969.
These objectives included:
(1) To mobilise the savings of the people to the largest possible extent and to utilise them for productive purposes in accordance with our plans and priorities;
(2) To ensure the operations of the banking system for a larger social purpose and to subject them to close public regulation;
(3) To meet the legitimate credit needs of private sector industry and trade, big or small;
(4) To meet in an increasing manner the needs of productive sectors of the economy and in particular those of farmers, small scale industrialists and self-employed professional groups;
(5) To actively foster the growth of the new and progressive entrepreneurs and credit fresh opportunities for hitherto neglected and backward areas in different parts of the country;
(6) To curb the use of bank credit for speculative and other unproductive purposes;
(7) To develop adequate professional management and modern managerial techniques and practices in the banking field;
(8) To provide adequate training and reasonable terms of service to bank staff;
(9) To considerably expand the branch network 0f bank in all parts of the country, and
(10) To reduce regional and sectoral imbalance in banking and through that in economic development.
A Critical Appraisal of the Functioning of Nationalised Banks in India:
With study the extent to which bank nationalisation has been able to achieve its objectives.
The nationalisation of 14 commercial banks on 19 July, 1969 was a watershed in the history of Indian banking. Together with the State Bank of India and its 7 associates which were brought under public ownership in the 1950s, the nationalisation of 20 commercial banks thereafter resulted in bringing about 90% of banking business under the direct control, ownership and management of the public sector.
We enumerate below some of the achievements of nationalisation:
1. Branch Expansion:
There has been a sea-change in the banking landscape, both geographically and functionally. The objective of creating an infrastructure for banking activity has, by and large, been achieved. From 6,596 branches and offices in June 1969, their number increased to 32,643 in June 2003.
2. Deposit Growth:
Besides, there has been functional diversification in the form of growth in bank deposits. The deposits of these banks in June 1969 were Rs..3,897 crores which increased to Rs.6,88,361 crores in March 2003 and grew by 11.47 per cent during 2002-03 over 2001-02.
3. Credit Expansion:
There has been an impressive record of the nationalised banks in the realm of credit expansion. The amount advanced by them increased from Rs.3,035 crores in June 1969 to Rs.3,60,147 crores in March, 2003 and grew by 14.12 per cent during 2002-03 over 2001-02.
4. Priority Sector Lending:
These banks have undergone a major transformation from ‘wholesale’ banking to ‘retail’ banking. In other words, there has been greater emphasis on disbursing credit to the priority sector comprising’ agriculture, small scale industry, transport operators, retail trade, professional and self-employed persons, and education.
The priority sector lending by the nationalised banks increased from Rs.441 crores in June 1969 to Rs.2,03,095 crores in March 2003. As percentage to net bank credit, the same increased from 14.6% to 42.5 during the above period. Agricultural advances increased from 5.4% to 15.3%, the share of credit to SSI units increased from 8.5% to 11.1 and the share of other priority sectors in overall net bank credit increased from 0.7% to 15% during the same period.
5. Spread of Banking in Rural Areas:
Since nationalisation, the spread of banking has increased considerably in rural areas. As a result of the deliberate policy of opening a large number of branches in rural areas, 63.1 % of the branches of the 19 nationalised banks were operating in rural and semi-urban areas in June 2003 as against 22% on the eve of nationalisation in June 1969.
6. Reduction in Regional Disparities:
Regional imbalances in the availability of banking facilities have been considerably reduced. The majority of these branches have been opened in unbanked areas. In June 1969, there were 74 bank branches in Assam, 172 in Haryana, 42 in Himachal Pradesh and only 2 in Nagaland.
In June, 2003 their number had increased to 1,212; 1,580; 784 and 70 respectively. 35% of branches had been opened in those States where banking facilities were less. Consequently, the average population per bank office declined to 16,000 in June 2003 against 65,000 in June 1969.
7. Some New Schemes:
Public sector banks have been departing from their traditional role and introducing some new schemes. Besides launching a range of new savings and other innovative schemes, these banks have taken up merchant banking and leasing and have also been floating mutual funds and venture capital funds.’ A number of other steps have been taken up to improve customer service. Courier services have been introduced to expedite collection of outstation credit instruments.
Nomination facilities have been extended to the depositors to avoid hardship to the legal heirs of deceased account holders. Customer service centres have been set up in all major cities. Customer relations programmes are organised periodically.
The system of personal hearing of the grievances of customers has been introduced at appropriate levels to serve the customer better. Nine nationalised banks have opened offices in foreign countries thereby opening new vistas in international trade and finance.
Despite the above enumerated achievements, the public sector banks suffer from a number of weaknesses which are discussed as under:
1. Deterioration in Customer Service:
One of the important drawbacks of nationalisation of banks has been deteriorating customer service. The evils connected with public sector undertakings have crept in these banks thereby resulting in red-tapism, inordinate delays and lack of responsibility.
Despite the directives of the RBI for improving the quality of customer service, little has been done to implement it at the branch level. For instance, there are delays in opening of the counters and sometimes counters are closed for short periods on flimsy grounds causing inconvenience to customers.
The branch managers are helpless to control the staff due to the spread of unionism. Complaint boxes are not maintained in many branches nor are the addresses of regional/zonal managers displayed to help customers who want to appeal to higher officers.
Facilities like automatic credit of outstation cheques of Rs.5000 and above and crediting of interest at savings bank rate in case of collection of outstation cheques being delayed beyond three weeks are not being extended to customers. Moreover, most bank branches give demand drafts against cash to businessmen towards the end of the day.
2. Political Interference:
There has been much political interference in granting of loans by public sector banks which has destroyed the sanctity of banking norms. This defeats the very purpose of social banking and leads to malpractices. An important instance is politically organised loan melas.
3. Social Banking Inadequate:
Social banking in the form of flow of credit to the priority sector is inadequate. It is less than the total advances of public sector banks. Even today these banks mainly cater to the needs of the corporate sector.
4. Window-dressing of Balance Sheets:
Some of the public sector banks have been resorting to window- dressing of their balance sheets so that their balance sheets do not reveal the actual state of affairs. They artificially step up their deposits in the last week of the fiscal year. This has been possible because auditing in the banks is incomplete and partial.
5. Large Scale Irregularities:
A number of public sector banks have been resorting to large scale irregularities in their operations.
Some of these are:
(i) Indulging in Share Speculation:
A few banks have started Mutual Funds and subsidiary financial companies and instances have been found of their involvement in share speculation. For instance, Bob Fiscal, a subsidiary of the Bank of Baroda arranged for funds for the Reliance Company in order to corner the shares of Larsen & Toubro. The securities scam involving Harshad Mehta and others revealed the involvement of the SBI and a number of other banks.
(ii) Favouritism in Granting Loans:
Some of the banks are guilty of favouring certain companies in granting loans. For instance, Vijaya Bank advanced large loans to a certain big industrial house and its group companies in small tranches so as to avoid clearance under the credit authorisation scheme.
(iii) Bad Quality of Loan Portfolios:
Despite the bad quality of loan portfolios, the banks have been advancing loans under extraneous pressures. Some of the banks have been extending letters of credit and guarantee limits as a routine affair without adopting normal commercial procedure in granting loans.
The non-performing assets (NPAs) of banks reflect the quality of their loan portfolios. NPAs include sub-standard assets, doubtful assets, loss assets, etc. During 1999-2000, the gross NPAs of public sector banks were Rs.53,294 crores, constituting 14.0 per cent of their gross advances.
(iv) Irregularities in Accounts:
Some of the public sector banks have been resorting to large scale irregularities in operating their accounts. In certain cases, .bad accounts have been taken over by one bank from the other without proper scrutiny and judgement.
(v) Large Bad Debts:
These banks have accumulated large amounts of bad debts. As on 31 December 1999, there were 3,185 cases of frauds involving Rs.640 crores of public sector banks.
The most important problem of the nationalised banks has been their declining profitability. Irregularities and corruption in lending operations, misappropriation, fraud, rising operating cost, deterioration in customer services, etc. have led to declining profitability of these banks. The ratio of net profit to total assets was (-) 1.15% in 1993-94 which improved to only 0.96 per cent in 2002-05.
7. Some Banks as Sick Units:
In October 1990, the Reserve Bank of India in a survey found all the nationalised banks in a bad shape and identified eight banks as ‘sick’. The ‘sick’ included: New Bank of India, Punjab and Sind Bank, Bank of India, UCO Bank, Vijaya Bank of India, Syndicate Bank, Bank of Maharashtra, and United Bank of India.
Some of these banks had eroded their reserves and paid-up capital and there had been erosion of their deposit base. To this ‘sick-list’ were added: Central Bank, Indian Overseas Bank, Allahabad Bank, Andhra Bank, and Dena Bank, in 1992.93.
New Bank of India became so sick that the Government merged it with Punjab National Bank effective 4 September 1993. During 1999-2000, three nationalised banks had been identified as weak. To adjust the losses of weak banks, the Government had contributed Rs. 20,466 crores towards their recapitalisation by 31 March 1999. But no amount was provided during 1999-2000. However, it provided Rs.297 crores towards writing down of the investments of Vijaya Bank for adjustment of its losses.
8. Low Capital Adequacy Ratio:
Every bank is required to achieve minimum capital to risk assets ratio, known as capital adequacy ratio (CAR) of at least 9 percent. Out of 27 public sector banks, two banks had not achieved it during 2002-03.
In a confidential report, the World Bank came out with trenchant criticism of the Indian banking system and called for urgent reforms. Since nationalised banks account for more than 90% of the assets of the entire banking in India. The World Bank’s criticisms was directed against the sloppy management of these banks.
The Report noted that these “banks were uncompetitive, overstretched, overstaffed and often provide poor service”. It suggested a number of urgent reforms like cutting subsidized loans to targeted socially backward areas by half, making rates more flexible and rational, and giving commercial banks a measure of operational autonomy.
The fault also lies with the Government which has placed these banks under the Banking Department of the Ministry of Finance with the result that the RBI cannot regulate the working of these banks independently instead of sharing the responsibility with a parallel controlling authority.
This dyarchy must go. There must be a thorough review of the working of these banks. The secrecy clause must be scrapped and the banking business made open and accountable. The defaulters must be identified. The machinery for the grant and recovery of loans should be streamlined and the entire procedure should be closely monitored.
Keeping these in view, the Finance Ministry and RBI took a series of measures to improve the performance and profitability of public sector banks. These included augmentation of capital, higher coupon rates on Government securities and higher return on cash balances. The banks were advised to draw up Action Plans to improve their operational efficiency.