In the recent clamour for their re-privatisation, we seem to have forgotten the rationale for bank nationalisation and the crucial role public sector banks continue to play in war against poverty
The widespread excitement around re-privatisation of public sector banks (PSBs) appears to betray ignorance of both the basics of economic theory as well as large facts of Indian credit markets. I had occasion to revisit these recently when I delivered the inaugural KN Raj Memorial lecture at my alma mater, the Centre for Development Studies, Thiruvananthapuram.
The legendary economist and institution-builder K N Raj was the one who explicated the intellectual case for bank nationalisation in the 1960s. Economic theory explains why banking enterprises seeking to maximise their profits would not venture into areas and sectors of activity, which may otherwise have great strategic social and economic significance. As John Maynard Keynes argued, there are two types of risk that affect the volume of investment. The borrower’s risk arises because she is unsure whether her business venture will provide the expected yield. As a borrower, she wants a low rate of interest, especially if her venture is a risky one. But the same situation creates the lender’s risk of default by the borrower, which can either be voluntary (moral hazard) or involuntary (due to poor returns on investment). This means that the lender must charge a rate of interest high enough to induce him to lend. Keynes expresses the resulting social dilemma somewhat poetically: “The hope of a very favourable outcome, which may balance the risk in the mind of the borrower, is not available to solace the lender.” There are also high information and transaction costs of dealing with many small borrowers that act as a major disincentive for lenders.
These insights of economic theory are corroborated by the historical context of 1969, the year 14 private banks were nationalised. At the time, not even 1 per cent of India’s villages were served by commercial banks. While industry accounted for a mere 15 per cent of national income, its share in commercial bank credit was 67 per cent. Agriculture that contributed 50 per cent of GDP virtually got nothing from banks. After nationalisation, the number of rural bank branches increased dramatically. By 2019, 99 per cent of villages with a population of less than 2,000 had access to banking services. It is the easier availability of credit that fuelled India’s Green Revolution and even today it is these banks that are the biggest formal source of credit at tolerable interest rates for the poor in rural India, who are otherwise forced to pay anywhere between 5 and 10 per cent per month as interest to usurious moneylenders.
Of course, there is a definite need for reforms in PSBs, since the policy of “social coercion” adopted after nationalisation achieved only limited success and dependence on usurious rural moneylenders actually grew after strict profitability norms were applied to PSBs in 1991. But over the past 10-15 years, very promising progress has been achieved in resolving the trade-off between access to affordable credit and banking profitability. This has been made possible by linking women’s self-help groups (SHGs) with PSBs, which has made inexpensive credit available to the poor, even as banks have reduced transaction costs and improved profitability, thanks to the impeccable financial discipline and extraordinary repayment record of SHGs.
I have been personally involved in the formation of thousands of SHGs over the past decade in the most deprived parts of central tribal India. Now it is not social coercion or even social responsibility that drives the lending to SHGs but robust business considerations of PSBs. We shudder to think of what will happen once PSBs are privatised, as proposed in the Union Budget of 2021. India’s most powerful instrument in the battle against poverty could be deeply compromised, since in our long experience we have never found any private bank willing to contemplate lending to SHGs in these remote areas. We must also worry about how the impetus to universal financial inclusion could falter as a result of bank privatisation. Rather than privatisation, what is urgently required are reforms to improve the quality of the PSBs’ relationship with SHGs and much greater state support to the SHG-bank linkage programme. This will enable it to reach critical mass and tackle the root of the problem, which lies in unregulated credit markets, where the balance of social and economic power ensures that these markets work against the interests of millions of small and marginal farmers and the landless poor in rural India.
Those arguing for their privatisation overlook the fact that many of the problems facing PSBs have arisen because of a fundamental shift in the thrust of economic policy in India. As fiscal stimuli have taken a backseat within the orthodoxy of austerity and with primacy being given to monetary policy, PSBs have been repeatedly forced into populist measures such as loan waivers or financing infrastructure projects, without requisite due diligence, which have damaged the integrity of the banking system. Such big-ticket loans have led to the burgeoning of non-performing assets (NPAs), which are then seen as a blemish in the performance of PSBs. Real PSB reform will lie in giving them greater autonomy and professional capabilities, rather than their privatisation, which could well be a disaster in the making.
The writer is Distinguished Professor, Shiv Nadar University, and former Member, Planning Commission, Government of India