THE GIST of Editorial for UPSC Exams : 09 August 2019 (Economic milestone and a poignant anniversary (The Hindu))

Economic milestone and a poignant anniversary (The Hindu)

Mains Paper 3: Economy
Prelims level: Nationalisation of Banks
Mains level: Background and significance of the nationalization of banks

Context

• The nationalisation of banks in 1969 was a watershed moment in the history of Indian banking.
• From July 19 that year, 14 private banks were nationalised; another six private banks were nationalised in 1980.
• It is certain that one cannot locate a similar transformational moment in the banking policy of any country at any point of time in history.

Background

• India’s rural financial system was marked by the domination of landlords, traders and moneylenders.
• In 1951, if a rural household had an outstanding debt of ₹100, about ₹93 came from non-institutional sources.
• From the 1950s, there were sporadic efforts to expand the reach of the institutional sector, particularly in the rural areas.
• Despite these measures, the predominantly private banking system failed to meet the credit needs of the rural areas. 

Class to mass banking

• India’s banking policy after 1969 followed a multi-agency approach towards expanding the geographical spread and functional reach of the formal banking system.
• As a part of a new branch licensing policy, banks were told that for every branch they opened in a metropolitan or port area, four new branches had to be opened in unbanked rural areas.
• As a result, the number of rural bank branches increased from 1,833 (in 1969) to 35,206 (in 1991).
• The concept of priority-sector lending was introduced. All banks had to compulsorily set aside 40% of their net bank credit for agriculture, micro and small enterprises, housing, education and “weaker” sections.
• A differential interest rate scheme was introduced in 1974. Here, loans were provided at a low interest rate to the weakest among the weakest sections of the society.
• The Lead Bank scheme was introduced in 1969. Each district was assigned to one bank, where they acted as “pace-setters” in providing integrated banking facilities. Fifth, the Regional Rural Banks (RRB) were established in 1975 to enlarge the supply of institutional credit to the rural areas.
• The National Bank for Agriculture and Rural Development (NABARD) was constituted in 1982 to regulate and supervise the functions of cooperative banks and RRBs.
• The share of institutional sources in the outstanding debt of rural households increased from just 16.9% in 1962 to 64% in 1992.

Growth spurring

• India’s nationalisation experience is an answer to mainstream economists who argue that administered interest rates cause “financial repression”.
• According to this view, if the government administers interest rates, the savings rate would decline, leading to a rationing of investment funds.
• India’s nationalisation led to an impressive growth of financial intermediation.
• The share of bank deposits to GDP rose from 13% in 1969 to 38% in 1991.
• The gross savings rate rose from 12.8% in 1969 to 21.7% in 1990.
• The share of advances to GDP rose from 10% in 1969 to 25% in 1991. The gross investment rate rose from 13.9% in 1969 to 24.1% in 1990.

A retreat

• The Narasimham Committee of 1991 recommended that monetary policy should be divorced from redistributionist goals. Instead, banks should be free to practise commercial modes of operation, with profitability as the primary goal.
• The Reserve Bank of India allowed banks to open and close branches as they desired.
• Priority sector guidelines were diluted; banks were allowed to lend to activities that were remotely connected with agriculture or to big corporates in agri-business, yet classify them as agricultural loans.
• Interest rate regulations on priority sector advances were removed.
• The outcomes were immediately visible.
• More than 900 rural bank branches closed down across the country.
• The rate of growth of agricultural credit fell sharply from around 7% per annum in the 1980s to about 2% per annum in the 1990s.
• This retreat of public banks wreaked havoc on the rural financial market. Between 1991 and 2002, the share of institutional sources in the total outstanding debt of rural households fell from 64% to 57.1%.
• The space vacated by institutional sources was promptly occupied by moneylenders and other non-institutional sources.

A to and fro

• In 2004, a policy to double the flow of agricultural credit within three years was announced.
• Only public banks could make this happen.
• So, in 2005, the RBI quietly brought in a new branch authorisation policy. Permission for new branches began to be given only if the RBI was satisfied that the banks concerned had a plan to adequately serve underbanked areas and ensure actual credit flow to agriculture.
• By 2011, the RBI further tightened this procedure. It was mandated that at least 25% of new branches were to be compulsorily located in unbanked centres.
• As a result, the number of rural bank branches rose from 30,646 in 2005, to 33,967 in 2011 and 48,536 in 2015.
• The annual growth rate of real agricultural credit rose from about 2% in the 1990s to about 18% between 2001 and 2015.
• Much of this new provision of agricultural credit did not go to farmers; it largely went to big agri-business firms and corporate houses located in urban and metropolitan centres but recorded in the bank books as “agricultural credit”.
• For this reason, the share of institutional credit in the debt outstanding of rural households in 2013 stood at 56%, still lower than the levels of 1991 and 2002.
• Yet, in achieving the high growth of credit provision, the expansion of public bank branches was pivotal.
• After 2005, public banks also played a central role in furthering the financial inclusion agendas of successive governments.
• Between 2010 and 2016, the key responsibility of opening no-frills accounts for the unbanked poor fell upon public banks.
• Data show that more than 90% of the new no-frills accounts were opened in public banks. Most of these accounts lie dormant or inactive, but it is unmistakeable that the fulfilling of the goal required the decisive presence and intervention of public banks.
• The same public banks were also India’s vanguard during the global financial crisis of 2007 when most markets in the developed world, dominated by private banks, collapsed.

Way forward

• However, despite such a stellar track record, the macroeconomic policy framework of successive governments has hardly been supportive of a banking structure dominated by public banks.
• In times of slow growth, the excess liquidity in banks was seen as a substitute for counter-cyclical fiscal policy.
• Successive governments, scared of higher fiscal deficits, encouraged public banks to lend more for retail and personal loans, high-risk infrastructural sectors and vehicle loans.
• Here, banks funded by short-term deposit liabilities were taking on exposures that involved long-term risks, often not backed by due diligence.
• Consequently, banks are in crisis with rising non-performing assets. The same fear of fiscal deficits is also scaring the government away from recapitalising banks.
• The solution put forward is a perverse one: privatisation. The goose that lays golden eggs is being killed.

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Prelims Questions:

Q.1) With reference to the Chief Minister, consider the following statements:
1. Under article 163(1) there shall be a Council of Ministers with the Chief Minister at the head to aid and advise the Governor.
2. Under article 164(2) the Council of Ministers shall be collectively responsible to the Legislative Assembly of the State.

Which of the statements given above is/are correct?
A. 1 only
B. 2 only
C. All the above
D. None

Answer: C
Mains Questions:
Q.1) How India can benefitted from the nationalization of banks since its started?