It was four decades ago, on 20 July 1969, that Indira Gandhi nationalized the country’s 14 largest banks as part of a leftward shift in economic policy that eventually led to the worst manifestations of the licence-permit raj and saw marginal income-tax rates go all the way up to 97%.
The most pernicious parts of that policy mix have been rejected in a long reforms process that started with Indira Gandhi herself in the early 1980s. However, the allure of bank nationalization lingers on.
In his recent Budget speech, finance minister Pranab Mukherjee tipped his hat to what he described as a “wise and visionary” move. He was echoing the sentiments of his political leader. In a talk she gave at the Hindustan Times Leadership Summit in November, Sonia Gandhi had praised Indira Gandhi’s decision to bring the major banks under government control.
Even the Reserve Bank of India (RBI), in the third volume of its official history, says that bank nationalization was a defining event. “It remains, without doubt, the single most important decision taken by any government since 1947. Not even the reforms of 1991 are comparable in their consequences—political, social and, of course, economic.”
There was political pressure to make banks serve the needs of an emerging socialist society ever since the Congress embraced the “socialistic pattern” at Avadi in 1956. In a 1967 memorandum to their party leadership, 118 Congress parliamentarians wrote that something must be done “to ensure that (banks) are managed by such persons who are motivated for the development of the socialist society”.
The eventual decision to nationalize banks was political, as Indira Gandhi bluntly told her economic adviser I.G. Patel, though there are now attempts to depict it as a move to promote inclusive growth and financial stability. Political control of banks meant political control over the entire economy.
In an article in 2000, economist P.R. Brahmananda wrote that the Congress had also appointed a committee of four economists to argue the case for bank nationalization. These economists made the case for nationalization on many grounds. Nationalized banks would expand to small towns, villages and lower-income groups; they would pre-empt credit for priority industries; pay attention to issues such as balanced regional development; take away the stranglehold that a few industrial houses had over national savings; ensure stability of credit institutions and inspire more confidence among depositors; and encourage healthy competition between large and small industrial houses.
There is little doubt that nationalization did help promote some of these goals, especially the ambition to reach out to villages and the poor. Banks expanded to all corners of the country and pulled millions into the formal financial system. There were fewer bank failures and more depositor confidence after nationalization. But the question is whether all this could have been done by better regulation rather than by nationalization, especially since there were also costs to be borne by the economy in terms of politicized lending, loan melas and a mountain of bad debts.
And we still see the old habits resurface each time a finance minister tells bankers how to price their loans and how much they should lend. Banking is perhaps the only area in the economy today where there are government-set targets.
Brahmananda cites an article he wrote in 1967 for The Financial Express, where he argued that bank nationalization was like “using a sledgehammer to strike a nail into the wall”. Curiously, socialist leader Madhu Limaye also argued in the same issue of the newspaper that social objectives could be achieved more efficiently without nationalizing banks.
There is no doubt that a country such as India could not develop without financial deepening and a growing financial system. Banks in the 1950s and 1960s were not doing enough. But these goals could have been advanced by regulations (social control) rather than change in ownership.
Contemporary defenders of bank nationalization also point to the financial crisis of the West, where governments have taken over banks that are tottering on the edge of bankruptcy. But the context is different. Western banks have been taken over because they took too many risks and not because they took too few (as was the case with Indian banks before 1969). Also, the current nationalizations in the West are temporary rather than permanent.
Whatever the likes of Sonia Gandhi and Pranab Mukherjee may now claim, bank nationalization has done more harm than good. And India could avoid making the mistakes made in the West during the bubble years because of prudential regulation by RBI rather than the fact that banks were nationalized four decades ago.
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