INDIAN BANKING (S.NATARAJAN, R.PARAMESWARAN)

Privatization of commercial banks

Privatization has become a popular measures for solving the organizational problems of governments by reducing the role of the state and encouraging the growth of the private sector enterprises. However, privatization takes a number of forms and has been approached in various ways during the move away from government control to other forms of ownership in developing countries. In 1969, on 19 July, an event of great political significance took place when the then Government, headed by Smt. Indira Gandhi, nationalized 14 major Indian banks. On 15th April, 1980, six more Private Banks were nationalized. Beginning 2nd October, 1975, 196 Regional Rural Banks have been establish in the country. After 31 years, the Government of India, introduced a Bill in the Public Sector Banks from existing “not less than 51%” to 33%. This intent was no doubt in continuation of the process of liberalization of the banking industry that began in the early 1990s. After the deregulation of interest rates, issuing of licences to new private banks, liberalizing of branch licensing policy, lending policy, even with recruitment policies of banks, it was natural to progress toward de-nationalisation.

Privatisation is a political process and has important economic and social implications that not only affect enterprise performance, but also social welfare and stability. The social effects have to be considered in any impact assessment, particularly those related to employment, social safety net measures, social privatization that results from the extension of share ownership to small investors and employees, and the role of public utilities and services in economic and social developments, including all forms of privatization, is clearly set in advance.

In the course of banking liberalization, Reserve Bank has so far granted licenses to 9 private sector banks up to March 2003. This apart, many foreign banks are allowed to set up branches / offices in India. Simultaneously banks were encouraged to go for mergers as in the case with Times Bank Ltd with HDFC banks and Bank of Madura Ltd with ICICI Bank Ltd.

The new privatization policy also led to a large-scale reduction in the staff strength PSU banks. We are aware that thousands of bank staff were shown the door under ‘VRS’ policy. However, the objective of privatization is to improve the functioning and profitability of Government owned banks. Let us now discuss the merits and demerits of this policy.

Arguments for Privatisation

The following may be the arguments for privatization of banks in India:

1. Public sector ownership has an inherent handicap due to it being extremely diffused. This makes it less amenable to effective control by shareholders, compared to private ownership.

2. Bank nationalization had given monopoly to the government in the banking industry. As in case of any monopoly situation, the quality of service went down and the people suffered.

3. State ownership of banks reduces competition and breeds inefficiency.

4. There is no evidence to suggest that State ownership lowers the probability of banking crises.

5. The sale of public equity of banks may be particularly lucrative now. Twelve of the 27 PSBs and 19 private sector banks are listed on stock exchanges, and the market has appreciated their recent performance. During the years 2001-03, all PSBs declared high profits, with some banks reporting 200 to 300 per cent growth in their bottom line! The bullish bond market enabled many banks to book record trading profits in trading in Govt. securities. Additional good cheer was the passage

of the new Act, which enables banks to seize the assets of defaulting borrowers.

6. A sixth rationale for privatisation is that it enhances efficiency and productivity through proper management and control.

7. The competition, not merely ownership, is the key. And foreign competitors might bring additional benefits take fresh capital as shown in other emerging markets. A foreign owned bank, with large capitalization, can withstand local disturbances better.

8. The private sector and foreign banks can resist local government pressure to lend to favoured sectors.

9. Frequent recapitalization of State-owned banks is a huge burden on Government budget.

10. The relative insensitivity of the public sector banking system to its cost structure, inability to respond quickly to the changing market trends and the greater rigidities in the management decision-making processes because of what may be described as ‘non-commercial’ considerations.

11. Dr. Jalan, Governor of RBI has given the following arguments in support of privatization of the banking sector :(i) “Indian legal system provides” full protection to the

private interests of the ‘public servant’ including in

the banks and further public sector banks have been afflicted with management by ‘non-commercial’ considerations. He believes that accountability to the shareholders will make sure that the officers stay on course.

(ii) Poor internal control and risk-management systems of the banks; and greater accountability on the part of corporate…”.

(iii) India should increase its domestic savings and invest them in the services sector to emerge a leader in the world economy. He also quotes W. Arthur Lewis to the effect that the central fact of economic development is that of capital accumulation and that would require an increase in the rate of domestic savings from 4 per cent to 12 per cent. India has failed to accumulate capital despite having secured such an increase in domestic saving because till the 1980s, the state-controlled financial system acted as deposit-taking agencies and providers of credit and finance for designated and centrally determined purposes…the public sector” instead of being a generator of savings for the community’s good-became, over time, a consumer of community’s savings “.

Arguments against Privatisation

1. One of the Directive Principles is that the Government would strive at redistributive justice in the country. Bank privatization is a step away from this direction.

2. Public sector banks in India have already been exposed to increasing competition. The forces of competition have already been pushed Public sector banks to optimize its resources an order to reach technical efficiency. It is felt that conclusions are being drawn on the basis of incomparable units – all of this to favour privatization and even foreign ownership.

3. Privatisation opens the way for the domination of the economy by foreign capital. Since it is extremely difficult to distinguish in practice between domestic and foreign capital within the private sector when they are operating together in joint ventures, or when a domestic firm can be a front foreign capital, any expansion in the scope for the private sector necessarily enlarges the sphere of operation of foreign capital as well.

4. Privatisation would remove a large chunk of the economy from the purview of public scrutiny and hence from the realm of social accountability. A basic distinction between public and private property consists in the fact that the

formers, in principle, is socially accountable, and this is enforced through Parliament and its committees. How well this job is done is a separate issue? If it is badly done then that requires reforms in a different sphere. But privatization puts an ends to this form of social accountability and hence constitutes in a fundamental sense an abridgement of democracy.

5. Social accountability is not merely intrinsically desirable. It becomes absolutely necessary when enterprises have to fulfill certain social functions going beyond mere profit making. Privatisation, and even making public enterprises concentrate exclusively on profit making, effectively does away with these social functions.

6. All privatization involves the selling of state property at “throwaway” prices. This is true the world over. And it has been true in India too as the Comptroller and Auditor-General’s report pointed out some time ago. In other words, in privatizing enterprises the state is not merely changing the form of its property from enterprises to schools or hospitals or reduced public debt but is transferring gratis some state property to private monopolists. Since state property has been built up through the through the sacrifices of the common people through tax payments or inflation-induced restraints on consumption, privatization amounts to an tax payments or

inflation-induced restraints on consumption, privatization amount to an implicit act of plunder, or what Marx called “primitive accumulation of capital”: a few are being allowed to filch from many through the courtesy of the state.

7. India has been a planned economy for the last about five decades. But in absence of any effective control over the commercial banks, the economic planning was incomplete and monetary policy targets were difficult to achieve and pursue. With the nationalistion of banks, the government could actually plan and pursue the monetary policy targets and it would be wrong to say that the decision of bank nationalization was a mistake.

Indian banking - past, present and future

Developments in Indian Banking: Past, Present and Future

“The Indian banking system faces several difficult challenges: therefore, banks have to reorient their strategies in the light of their own strengths and the kind of markets in which they are likely to operate.”

Dr.T. K. Velayudham

The Indian Banking system is unique and perhaps has no parallels in the banking history of any country in the world. It is interesting to study the evolution of Indian Banking over the last five decades, in terms of organisation, functions, resource mobilization, socio-economic role, problems and solutions. The period of five decades witnessed many macro-economic developments, monetary and banking policies and the external situation which influenced the evolution of Indian banking in different ways and in different periods. For this reason, it would be useful to analyse in some detail the evolution of Indian banking with reference to some distinct phases. The first phase covers the period from 1948 to 1968 and the second phase from 1969 to 1991. These two periods

constitute the past. The period of banking reforms beginning with 1992 and till the year 2002 may be regarded as the present or the current phase for the purpose of this analysis. It is the current phase which provides the basis for looking into the future of Indian banking system.

1. First Phase: 1948-1968 Banking before Nationalisation

It is useful to trace briefly the banking situation in India at the time of independence of the country in 1947. The country inherited a banking system that was patterned on the British banking system. There were many joint stock companies doing banking business, and they were concentrating mostly in major cities. Even the financing activity of these banks was confined to exports of jute, tea, etc; and to traditional industries like textiles (jute, cotton) sugar. There was no uniform law governing banking activity. An immediate concern after the partition of the country was about bank branches located in Pakistan and steps were taken to close some of them as desired by that country. As a result of mushroom-ike growth of banking companies, bank failures were very common in those days. In 1949 as many as 55 banks either went into liquidation or went out of banking

business. Banking did not receive much attention of the policy makers and disjointed efforts were made towards the regulation of the banking industry.

After Independence

The first step was to create the legislative framework appropriate for banking in a newly independent nation. The Banking Regulation Act passed in 1948 provided the legal framework for the regulation of the banking system by the Reserve Bank of India (RBI). The Act, which came into force in March 1949, imposed certain discipline on the joint stock companies doing banking business in India. As a result, the banking industry came to be organized for the first time on certain uniform parameters. The Act prohibited the use of the word ‘Bank’ by financial companies which were not complying with certain minimum requirements i.e. a minimum paid-up capital and reserves. This stipulation, which came into force from March 1952, led to a process of weeding out financially weak banks. A number of banks went into liquidation.The RBI, which was vested with greater powers of control over the banks started collecting data from 1949 on various aspects of banking. There were 620 banking

companies, big and small, scheduled and non-scheduled, operating mostly in state capitals and in urban centre. The total number of branches was 4,263. Total deposits and advances were Rs. 997 crore and Rs. 518 crore respectively. Investments were Rs. 376 crore. Imperial Bank of India was the biggest bank in those days with 433 branches. The present day subsidiaries of the State Bank of India were independent banking companies mostly in the former princely states. Besides the Indian banks, there were 15 Exchange Banks (foreign banks) with branches in big cities only: and they were dealing mostly with international banking i.e. financing the export and import of commodities. The banking system at the time of independence was deficient in many respects. The banks were largely urban-oriented and remained beyond the reach of the rural population had to depend on the money lender as their main source of credit. Banks’ rural penetration was grossly inadequate, as agriculture was not considered as economic proposition by banks in those days. Thus, the agricultural sector, the crucial segment of the Indian economy was not supported by the banking system in any form. Moreover, security oriented lending was the order of the day. Only 4 per cent of the total advances was made without any security. Another serious

deficiency was that the focus of banks was entirely on short-term credit. There were no well developed capital markets: nor was there any term-lending institution except for the Industrial Finance Corporation of India set up in 1948.

Plan Era

With the introduction of economic planning in 1951, the need was felt for aligning monetary and banking activity with the requirements of planning. The first five-year plan observed that RBI as the Central Bank should create the machinery needed for financing development and ensure that the finance available flows in the directions intended. The objective was to widen and deepen the flow of agricultural and industrial credit. The trust was on the rejuvenation of the rural economy and the banking system had to be geared to this. The branch expansion by banks and increase in rural credit including credit to the small-scale sector became imperative. The All-India Rural Credit Survey Committee appointed by the RBI reviewed the rural credit scheme in 1954 and brought out the maladies of the rural economy arising out of capital starvation. The committee made a few major recommendations for improving the flow of rural credit.

On the basis of its recommendations, the Imperial Bank of India was nationalized and renamed as State Bank of India (SBI) from july1955. The new bank was charged with the responsibility of expanding its rural branch network within a time frame. Thus the first step was taken to induct the commercial banks into rural credit, which was till then reserved for co-operative credit agencies who were waging a battle against money lenders. As part of process of geographical expansion of banking facilities to meet the credit needs of co-operatives, certain banking companies functioning in former princely states were converted in 1959 into subsidiaries of SBI, later came to be known as associate bank of SBI.In 1960, the crash of Palai Central Bank in Kerala, shook the confidence of the public in the banking system: and the RBI came out with two schemes to stabilize the banking system. One was the establishment of the Deposit Insurance Corporation, to insure the deposits of small depositors. The second scheme was the compulsory mergers and amalgamations of banks of weak financial structure, with bigger and viable banks. Simultaneously, in terms of the Banking Companies (Amendment) Act, 1963, RBI acquired powers to; restrain control over the affairs of banks of particular groups of persons; regulate

loans, advances and guarantees given by banks and appoint/remove banks, executive personnel. In 1966, the co-operative banking system was brought within the statutory supervision and control of RBI. During these years Indian Banks established overseas branched to increase their participation in external trade i.e. foreign exchange transactions.There were some qualitative changes in the banking activity during these years. There was a shift in the financing of industries; there was a decline in the financing of industries; there was a decline in the financing of textiles and sugar industries and with emphasis of the Second Five Year Plan on heavy industry development, the financing of cement, chemicals, iron and steel and engineering industries became prominent. Export financing also attracted attention, leading to the setting up of Export Credit Guarantee Corporation in 1964 to compensate exporters for the losses they might sustain. There was also some shift in the method of lending from security based to capacity-to-produce-and-sell criteria. A review of the ownership of bank deposits during this period revealed the nexus between business houses and banking companies, indicating the nature of control of banks by business houses.

ON THE EVE OF NATIONALISATION

Even though Indian banking made considerable progress both functionally and in terms of geographical coverage during this period, there were still many rural and semi-urban areas which were not served by banks. Moreover, large industries and big and established business houses tended to enjoy a major portion of the credit facilities. Vital sectors like agriculture, small scale industries and exports did not receive the attention they deserved. Therefore, the government imposed in 1968 social control over banks by amending banking laws. The objective was to achieve efficient distribution of banking resources in conformity with the requirement of the economy and to meet the needs of the priority sectors. In this process RBI acquired wider powers in matters of appointment of heads of banks, directors on the boards of Banks and auditors.

The outcome of implementation of social control over banks is of interest. One is that the system of credit planning became an integral part of formulation of credit policy. Second, the introduction of the Lead Bank scheme was to make the banking system function as an instrument of development. Under social control the banking system including smaller banks started gaining strength as evidenced by the absence of

voluntary or compulsory mergers of banks. Thus, social control was a milestone in the evolution of banking policy.