Nationalism and Development of Banking in India

The banking system in India is not a new phenomenon and its earliest evidence can be traced back to the vedic civilization. The evidence of the banking system can be found in Vedic texts, manusmriti etc. Kautilya's Arthashastra refers to the presence of bankers during the mauryan period. The Businessman of ancient time who were known as Shroff's, Sahukars, Mahajana etc. were involved in the banking business. But the evolution and development of the modern banking system can be traced back to the British era. The first modern bank set up in India was Bank of Hindustan in 1770.

Banking system forms the base of the economy and economic development. It is responsible for more than 70% of fund flow of the financial sector of the country. The development of the Indian banking system can be segregated into two phases:

  • Pre independence era (1786 to 1947 )
  • Post independent era (after 1947)

Pre independence era (1786 to 1947)

  • The roots of the modern banking system can be traced back to the establishment of the bank of Calcutta in 1786. Later on the British setup Presidency Banks at Bengal, Bombay, and Madras.
  • The Bank of Calcutta was set up on 2nd June 1806. The bank of Bombay was set up on 15 April 1840, and the Bank of Madras was established on 1st July 1843.
  • These three Presidency banks were merged in 1921 and a new bank was formed which was named as the Imperial Bank of India. Later on, in 1955 the Imperial Bank of India was nationalised by the government and was renamed as the State Bank of India.
  • Allahabad Bank, established in 1855 was the first Indian owned Bank. The Punjab National Bank was set up in 1895. The Bank of India was established in Mumbai in 1906.
  • Between 1906 and 1913 many commercial banks including India bank, Central Bank of India, Bank of Mysore, Canara Bank, and Bank of Baroda was set up under the Indian ownership.
  • Reserve Bank of India (RBI) was established in 1935 on the recommendations of Hilton young Commission, the Royal Commission on Indian currency and Finance set up by the British government. The RBI started functioning as the central bank of the country. It is a statutory body established through RBI act 1934.
  • During this phase, the development of banking system in India was very slow and it experienced periodic failures. The banking system neglected the rural and agricultural sector and was mostly concentrated in the urban areas.

Post independence phase can further be categorised into three phases

  • Pre nationalisation phase (1947 - 1969)
  • Post nationalisation phase (1969 - 1991)
  • Post liberalisation phase ( after 1991)

Post independence phase (1947 - 1969)

  • At Independence, the ownership of the banking system in India was mostly in private hands. The rural population lacked access to the formal banking system and they were mainly dependent on money lenders for their credit requirements.
  • The Reserve Bank of India was nationalised by the government of India in 1949 through the Reserve Bank (Transfer to public ownership) act, 1948. The Reserve Bank of India started working as a government owned Bank from 1st January 1949. RBI was provided extensive powers to supervise the banking system in India, and it worked as the central banking authority of the country.
  • The Banking Companies Act, 1949 later changed to the Banking Regulation Act, 1949 was enacted by the government to streamline the functioning of the commercial banking system in India.
  • The Imperial Bank of India was nationalized and renamed as the State Bank of India in 1955. This was done via State Bank of India Act, 1955.
  • Later on, 7 subsidiaries of SBI were Nationalised in 1959 through the State Bank of India (Subsidiary Banks) Act 1959.
  • During this phase, people had less confidence in the banking system as the deposit mobilisation was slow. Mostly, the traders benefited from the funds given by these banks. Also, the saving bank facility which was provided by the Postal department was considered safer option.

Post independence phase (1969 - 1991)

Nationalisation is the process in which the government takes over the ownership of private industry or organisation by an act of parliament or ordinance etc.

  • The first major dose of nationalisation of banks took place on 19th July 1969 when the government Nationalised 14 major commercial banks. All the commercial banks having a deposit base of over rupees 50 crores were nationalised.

List of banks Nationalised in 1969

  1. Allahabad Bank
  2. Bank of India
  3. Bank of Baroda
  4. Bank of Maharashtra
  5. Punjab National Bank
  6. Canara Bank
  7. Dena Bank
  8. Central Bank of India
  9. Indian Overseas Bank
  10. Indian Bank
  11. Syndicate Bank
  12. UCO Bank
  13. United Bank
  14. Union Bank of India
  • In 1971, credit guarantee Corporation was created. In 1975, regional rural banks were created.
  • In 1980 second phase of nationalisation took place and six more banks having deposits over 200 crores were nationalized by the government. By 1980, 80% of the banking sector came under the government ownership.

List of banks Nationalised in 1980

  1. Andhra Bank
  2. Corporation Bank
  3. Vijaya Bank
  4. Oriental Bank of Commerce
  5. New Bank of India
  6. Punjab and Sindh Bank

Major Objectives behind nationalisation of banks in India

  • To provide credit facilities to the needy and required sectors- some sectors of economy such as agriculture, village and small scale industries lacked access to formal credit support. The nationalisation of banks was aimed to provide easy access of funds to these sectors of the economy.
  • To control private monopolies- before the nationalization of commercial banks, most of them were controlled by the corporate houses. Due to this, it became extremely difficult for new business units to enter any line of business. It became essential to control the monopolistic nature of banking system to ensure credit supply to all the sections of society.
  • To ensure the expansion of banking system in rural areas- the banking system at that time was mainly concentrated in the urban areas and the rural areas were generally un-banked. Thus nationalisation was essential to ensure a rapid branch expansion in rural areas. This was also aimed to mobilize rural savings in the formal banking system.
  • Failure of social control- many of the private banks did not follow the regulations and measures given by the government under social control . Thus nationalisation became necessary due to the failure of social control.
  • To ensure balanced regional development: India was facing a big urban-rural divide in the availability of financial resources and credit facilities. Private banks had neglected the backward areas as these areas had less profit opportunities. The nationalisation of banks was seen as a path to reduce regional disparities and achieve balanced inter regional development.
  • Greater control by RBI- since India is a developing country strict control of the central bank over credit created by banks is essential. The nationalisation of banks made it easier for the RBI to ensure coordinated credit control in the banking system.
  • Greater stability in the banking system: Nationalised banks are more stable and safe as they are government owned. They command more confidence with the public with regard to the safety of their deposits. The planned development of nationalised commercial banks was also aimed to provide greater stability to the banking structure.
  • Nationalisation of banks was also seen as a necessary step to develop banking habit among the rural population.

Arguments supporting the nationalization of banks

  • Nationalisation would have made the banking system more stable and safe which was necessary to increase public confidence to ensure a rapid increase in deposits. It was also necessary to prevent Bank failures.
  • Nationalisation of banks was seen as an instrument to increase profit and revenue of government. Nationalisation of banks had already been done in many other countries.
  • It was to remove the concentration of wealth and economic power in the hands of a few corporate houses.
  • Nationalisation of banks was to enable diversification of resources of the banking sector for the benefit of the priority sector.
  • Nationalisation was necessary to eliminate wasteful competition and improve the efficiency of the banking system.
  • Nationalisation of banks was necessary to fulfill the socialistic goals present in our constitution and to take care of the interest of the community.
  • It was to replace the profit motive of the banking system with service motive.
  • It was to check tax evasion and accumulation of black money in the country.
  • The public sector banks were to function like any other public utility to serve the financial needs of common man.
  • To ensure the success of the planned model of development and ensure all round progress of economy and community, nationalisation of banks was necessary.
  • It was to enable RBI to implement monetary policy more efficiently and effectively.
  • It was to ensure standardization of banking services in India.

Criticism of nationalisation of banks

  1. Nationalisation of banks was criticized as an instrument to use the financial resources of the economy to serve the political purpose rather than the productive purpose.
  2. Nationalisation of banks has been criticized for vesting enormous powers in the hands of RBI for controlling banks resources. It has been criticized as the beginning of state capitalism by replacing corporate capitalism.
  3. Nationalisation of banks has been criticized for increased inefficiency and corruption in the banking sector. The increase in non performing assets in the public sector banks is an example.
  4. Public sector banks have been criticized for providing less attractive customer services and increasing red tapism.
  5. The argument of branch expansion in rural areas has been criticized as branch expansion is possible only if it is economically viable. This can be achieved even by the private banks.
  6. The government had to pay heavy compensation to the shareholders of these banks during nationalisation. Also, it was argued that this would not bring much profits to the government

Despite these criticisms, nationalisation of banks in India did achieve some concrete success. This step of government received support from small industrialists, small traders, middle class etc.

Achievements of Nationalised banks

  • Expansion of bank branches: after the nationalization of banks, the branches of public sector banks increased by 800% from 7219 to more than 57000. The branch expansion occurred not just in urban areas but also in rural and backward areas.
  • Expansion of bank deposits: the bank deposits have increased by more than 200 times since nationalisation of banks took place. This was achieved due to increased publicity of public sector banks after nationalisation.
  • Expansion of credit facilities- nationalisation of banks have significantly increased the availability of credit facilities to different sectors of the economy. It now meets the credit requirements of industry, trade agriculture and other important sectors.
  • Advances provided to the priority sectors: nationalisation of banks enabled credit facilities to so far neglected sectors such as agriculture, small scale industry, retail trade and small business etc. As per the norms of RBI, the scheduled commercial banks now have to give 40% of their loans to the priority sector.
  • Social banking and poverty alleviation schemes: the nationalised banks have been the leading participants in the poverty alleviation schemes launched by the government.
  • Differential interest schemewas introduced by the government to provide concessional credit to the weaker sections. Under this scheme, the nationalised banks provide loans at 4% interest rate to economically weaker sections society.
  • Safety of banking system- the nationalization of banks has improved the safety of the banking system as RBI exercises strict control over these banks to safeguard the interest of depositors.
  • Nationalised banks despite various challenges of achieving economic and social objectives have been able to generate profit and revenues for the government.
  • Public sector banks have played an important role to provide self employment opportunities through various government schemes like IRDP, JGSY etc.

Liberalisation phase of Indian banking system (after 1991)

  • To deal with the newer challenges emerging after the liberalisation of Indian economy in 1991, the government of India set up M. Narasimham committee to recommend measures for the reform of banking system of India.
  • The committee recommended several measures for the liberalisation of banking practices in India. Many products and facilities were introduced in the banking sectors and effort was made to give priority to customer satisfaction on banking services.
  • The committee recommended that there was no more need for nationalisation of banks. Foreign banks were now allowed to open offices in India.
  • The committee recommended for equal treatment for public sector banks and private sector banks by RBI and the government.
  • RBI gave licenses to 10 new private players to enter the banking sector. It included ICICI Bank, HDFC Bank, Global Trust Bank, Bank of Punjab, Axis Bank, IndusInd Bank, IDBI Bank, Centurion Bank, Times Bank and Development Credit Bank.

Despite several challenges, the financial system of India has proved to be resilient and stable. The system of checks and balances such as flexible exchange rate regime, high foreign exchange reserves, capital account being not fully convertible, limited exposure to foreign exchange etc have saved Indian financial system from any external macroeconomic shocks.

Today Indian banking system though having a healthy growth is facing challenges of non-performing assets and bad loans which needs to be tackled efficiently. An efficient and effective banking system is essential for economic development of the country.

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