Nationalization of Commercial Banks

The Indian banking system consists of public sector banks, private banks, and foreign banks.
Several of the public sector banks came into existence when the government decided to
nationalise 14 major banks with deposits of ₹50 crores or more in 1969.
Reasons for nationalization.
1. The commercial banking system did not play a satisfactory role in the planned
development of the nation. Many of the private banks came under the influence of
industrialists and businessmen who used bank funds to build a private industrial empire.
Small industrial units were not adequately served, even though the government policy
encouraged SSI.
2. Agricultural credit was never seriously considered by the banks.
3. Bank funds were used to support anti-social and illegal activities against the interest of the
public.
After 1969, once again in 1980, the Government of India took over another 6 commercial
banks. Altogether there were 21 nationalised banks along with State Bank of India and its
Associates banks [Taken over in 1955]. Over the last five years, consolidation of public
Sector Bank has taken place. As of 2022, there are 12 public sector banks.
Objectives
1. to mobilise savings and canalise them for productive purposes in accordance with plans.
2. To help in the most effective development of national resources.
3. to meet the needs of the productive sectors, particularly farmers, small scale industrialist
and self-employed.
4. To foster the growth of new and progressive entrepreneurs.
5. To create fresh opportunities in backward areas.
6. To create right atmosphere for the development of adequate professional management in
the banking field.
Progress/ achievements/ evaluation.
Public sector banks accounted for about 70 % of total deposits and 59.8 % of total advances
of all banks in India in 2020.
1. Branch expansion: after nationalization and introduction of lead bank scheme the bank
branches expanded. In 1969 the total number of branches were 8260 with only 22% in rural
areas. By 2019, the total number of branches were 87,526, with 33 % in rural areas. Public
Sector Banks have 1.34 lakh ATMs out of which 27,098 (20 per cent) are in rural areas. The
expansion of banks in rural areas has helped to serve the backward regions. However, the
provision of bank credit at concessional rates of interest to the farmers and rural artisans has also
contributed to low profitability of the banks.
2. Deposit mobilization: banks have contributed greatly to the development of banking habits
among people through sustained publicity and extensive branch banking. With a network of
bank branches and incentives to savers, deposit mobilization has increased from ₹5910 crores
in 1970-1971 to Rs. 2,10,9050 cross. In 2005- 06. Between 1971 - 1991, the deposits grew by
32.6 times and between 1991 - 2006 by 11 times.
3. Expansion of bank credit: The banks are meeting the credit requirements of industry, trade
and agriculture by expanding bank credit around 20 to 21% per year.
4. Development oriented banking: The public sector banks, after nationalisation have been
actively involved in lending funds to development-oriented activities, like meeting the needs
of industrial and agricultural sectors. They are not only lending for short term, but also
medium and long term. Bank credit is also being extended to the underserved- weak
industrial units. Small farmers and artisans. The lead bank scheme was a milestone in the
development effort. Under this scheme, all the districts of the country were allotted to some
bank or the other. The lead bank in the district was to open Bank offices in all important
localities, provide credit facilities for development and mobilise the savings of the people.
5. Priority sector lending of banks: The nationalised commercial banks had to provide priority
sector lending to agriculture, MSME, social infrastructure, and renewable energy, small
transport operators, retail trade, self-employed, education and housing loans for the weaker
sections have also been extended. This was to ensure that adequate institutional finance was
provided to these sectors, which make a significant contribution to the national product.
Priority sector should constitute 40% of aggregate bank credit and out of that at least 40%
should be provided to agriculture. Priority sector percentage to total bank credit went up from
12% in 1960 to 44% in 2005.
6. Social banking. The Government of India has used the public sector banks to finance many
of its poverty reduction and poverty alleviation programmes despite severe criticism. For
example, a differential interest rate scheme was introduced in 1972. The banks have provided
assistance under the Integrated Rural Development Program, Prime Minister’s Rozgar
Yojana for educated youth and scheme for Urban Micro Enterprises, Financial inclusion
schemes like Pradhanmantri Jandhan Yojana, Pradhanmantri Mudra Yojana, Rupay debit
cards.
7. The banks have also diversified their activities to include merchant banking, mutual funds,
retail banking and venture capital funds.
Problems faced by nationalised banks.
1. Losses in rural branches -High overheads and existence of barter system.
2. Large overdues; Waiving off all loans to farmers.
3. Nonperforming assets. There are high outstanding non-performing assets. They are unable
to maintain capital adequacy ratio.
4. Advance to priority sector- slow progress and also recovery rates are low.
5. Competition from non-banking financial institutions for deposit mobilization.
6. Competition with foreign banks.
7. Gap between promise and performance- Public sector banks. Continue to have procedures
which are old and outmoded. Bank staff have not adopted new work philosophy and new
social objectives.
8. Bureaucratization red tapism and delays.
9. Political pressure. Selection of personnel and in giving loans-a lot of political pressure is
involved.
Banking Sector Reforms – Narasimham Committee reforms
Why reforms?
1. Low operational efficiency
2. Low profitability with high and growing non-performing assets
3. Low capital base and lack of proper disclosure norms
4. Poor internal controls
5. Quality of customer service was not improving
6. Inefficiencies in the banking system were diverting domestic financial savings away from
the banks.
The banking sector reforms [1992-2006] were based on the recommendations of the
Narasimham Committee 1991 on financial sector reforms and the Narasimham Committee
report on the banking sector reforms, 1998. The reforms based on 1991 report aimed at
transforming the highly regulated and directed public sector banking system into one
characterized by competition, prudential and supervisory discipline. It was to ensure that they
will be able to meet the new challenges. The recommendations were aimed at.
1. Ensuring a degree of operational flexibility.
2. Internal autonomy in decision making.
3. Greater degree of professionalism in banking operations.
The reform measures included the following:
1. Reducing the Statutory Liquidity Ratio [SLR]. Since high SLR adversely affected
profitability of the banks and reduced availability of funds for lending, the SLR was reduced
from 38.5% to 25%. [2020: 18 %]
2. Cash Reserve Ratio [CRR]. The CRR was reduced to release funds blocked up with RBI
for lending to industrial and other sectors. The incremental CRR was abolished and CRR was
gradually reduced from 15% to 5.5% by December 2001. [2021: 3%]
3. Interest rate slabs reduced from 20 to 2 by 1994-95. Other features included[a] interest rate
on domestic term deposits has been decontrolled. [b]The prime lending rate was reduced. The
prime lending rate was later replaced by the benchmark prime lending rate and now Base
rate.
4. Prudential norms require the banks to make 100% provision for all non-performing assets.
The banks have to adopt the norms of classification of assets and bad debts to ensure that the
books of the commercial banks reflect their financial position more accurately and in
accordance with internationally accepted accounting practices.
5. Capital Adequacy norms were fixed at 8% by RBI in 1992.[Capital to risk weighted assets
ratio.]
6. The nationalised banks were allowed access to the market for capital funds through public
issues. However, government holding should not be below 51%.
7. Scheduled commercial banks were given freedom to open new branches and upgrade
extension counters.
8. Banks were to raise capital contribution from FII to 20%.
9. Banks to mobilise rural deposits.
10. Supervision of commercial banks was tightened by the RBI.
Recommendations of Narasimham Committee on Banking Sector reforms, 1998.
1. Need for a stronger banking system to handle the challenges of exchange rate management
and domestic liquidity in the context of capital account convertibility. Narasimham
committee has recommended merger of strong banks and that some banks could be given an
international character.
2. Narrow banking for weak banks. That is, weak banks to place their funds in risk free assets
to match their demand deposits by safe liquid assets.
3. Suggestion to set up small local banks which would be confined to states or clusters of
districts to serve local trade, small industry, and agriculture.
4. Raising the capital adequacy ratio to improve the inherent strength of banks.
5. Narasimham committee has recommended that the bank boards must remain responsible
for enhancing shareholder value through formulation of corporate strategy.
6. It has suggested the urgent need to review and amend the provisions of RBI Act and
Banking Regulation Act.
7. Others: computerization, professionalising and depoliticising bank boards and review of
their recruitment procedures.