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Home / IAS Preparation / Nationalization of Banks

Nationalization of Banks: History, Purpose, Benefits & More | UPSC Notes

Last Updated on Aug 21, 2024
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Nationalization of banks refers to the process where the government takes control of private commercial banks and converts them into public sector entities. This is mainly done to primarily help answer the twin purposes of more equal distribution of financial resources and promotion of financial inclusion throughout the country. By nationalization, the government wants to divert the country's financial resources to sectors like agriculture, small-scale industries, and several developmental projects. This shall ensure integrated economic growth. The first major step in regard to nationalization in India took place in 1969 by then Prime Minister Indira Gandhi. It worked like a revolution in the scenario of banking.

The topic of the nationalization of banks holds significant relevance for Union Public Service Commission (UPSC) exams, particularly within General Studies Paper III. This paper includes Economic Development, which encompasses banking reforms and policies, financial inclusion, and the comprehensive role that banking plays in the Indian economy.

GS Paper

General Studies Paper III

Topics for UPSC Prelims

Historical Context, Nationalization Phases (1969 and 1980), Objectives, Impact on Economy, Challenges and Criticisms, Financial Inclusion, Post-1991 Reforms, Legacy

Topics for UPSC Mains

Detailed Analysis of Objectives, Implementation and Impact, Role in Financial Inclusion, Political and Economic Implications, Challenges Post-Nationalization, Financial Sector Reforms, Comparative Analysis with Other Countries, Long-term Economic Development Effects

About the Nationalization of Banks

One of the most prominent events in the financial history of India was the nationalization of banks in India. The twin primary objectives of this policy intervention were to see that banking services reached the rural and semi-urban masses, thereby democratizing access to financial services, and to channel or direct the flow of credit to priority sectors. This exercise was first initiated in 1969 when 14 major private commercial banks were nationalized. This was followed by a second wave in 1980 with the nationalization of 6 more banks. Nationalization was aimed at making services associated with banks available to all people, so that the benefits of economic development were wide and spread all over.

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History of Nationalization

The process of nationalization in India began as a part of broader economic reforms. The banking industry was largely privately owned before independence; therefore, most of the banking activities remained concentrated in the rich and industrial classes. The first serious attempt at Indian-style banking was the formation of Punjab National Bank in 1894. After independence, the government felt the necessity of developing an effective and adequate banking system so that its socio-economic goals could be effectively implemented.

The seminal event came about on July 19, 1969, in the form of the nationalization of 14 major commercial banks with deposits exceeding ₹50 crores each, including Punjab National Bank, Central Bank of India, and Bank of Baroda. In April 1980, another six banks, including Andhra Bank and Corporation Bank, were nationalized, bringing the total to 20. This was done mainly to ensure that concentration of wealth was removed and the banking resources were channelized for the nation's benefits.

Read the article on the Indian Banks Association IBA!

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Need for Nationalization of Banks

There existed several reasons which made it necessary to nationalize the banks. These included:

  • Control Over Resources: Aggregating financial resources and using them for national priorities, mainly agriculture and small-scale industries.
  • Prevention of Bank Failures: Dozens of banks were failing in India in the 1950s and 60s, leading to a loss of public confidence.
  • Distribution of Credit Equitably: The private banks were mainly servicing the industrialists and ignoring other important sectors like agriculture and small industries.
  • Elimination of Monopolies: Removing banks from the control of a few business houses.
  • Support Economic Plans: Moderating the banking sector to meet the goals of the Five-Year Plans the government initiated for planned economic growth.

Read the article on the Insolvency and Bankruptcy Board of India IBBI!

Factors that Led to the Nationalization of Banks

A number of factors made nationalization imperative:

  • Economic Inequalities: There was a huge economic divide class, wherein major financial resources were controlled by wealthy business groups.
  • Growth in Non-performing Assets: The inefficiency of the private banks management resulted in an increase in NPAs, which posed a threat to economic stability.
  • Political Influence: The influence of the socialist ideologies among the Indian National Congress beckoned for more state control over critical sectors of the economy.
  • Public Demand: A growing public demand to make a banking system 'inclusive' and one that met the needs of the broader population.
  • Global Precedents: Other countries, for example, the UK, had nationalized their banks with reasonably good success; therefore it should also be possible in India.

Read the article on the Small Industries Development Bank of India SIDBI!

Benefits of Nationalization

The benefits of nationalization were noteworthy:

  • Increased Access to Banking: Nationalization took banking to the countryside and semi-urban areas, thereby considerably expanding financial inclusion. It threw open a plethora of bank branches—all the way up to about 50,000 by 1985 from about 8,200 in 1969.
  • Credit Allocation Alignment: Credit was oriented towards priority sectors; the share of agriculture in total bank credit increased from 2% in 1968 to about 15% by 1991.
  • Economic Stability: Public confidence in the banking sector was restored, and so the financial system was stabilized.
  • Employment Generation: Many people got job opportunities by way of the expansion and growth of the nationalized banks.
  • Infrastructure Development: These nationalized banks provided finance to government infrastructure projects, which supported the overall economic growth of the country. Thus, nationalization played a significant role in the infrastructural development of India.

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Arguments Against the Nationalization of Banks

Notwithstanding its advantages, nationalization faced severe criticism for the following reasons:

  • Bureaucracy and Inefficiency: Most of the nationalized banks have been suffering from bureaucratic inefficiencies, and as a result of state control over them, there is a loss of competitive vigor in their functions.
  • Political Interference: Greater control of the government has in fact invited political interference in banking decisions, usually ending up in non-meritorious loan disbursements.
  • Low Profitability: Public sector banks are generally less profitable with higher rates of NPAs than their private sector counterparts. The gross NPA ratio was 11.3 percent for public sector banks as of March 2020, while it was 4.9 per cent in case of private sector banks.
  • Non-Innovative: The public sector banks are usually slow to adopt new technologies and innovative banking practices.
  • Resource Misallocation: Priority sector lending has often resulted in less-than-optimal allocation of resources and generates inefficiency.

Read the article on wholesale banking!

Conclusion

The nationalization of banks in India was a transformational and strategic policy decision to reorient the banking structure so that it worked towards more egalitarian growth. Although this step ensured geographical expansion in banking services and oriented credit dispensation towards national priorities, it also led to certain problems of inefficiency and political interference. Thus, the positive and negative aspects of nationalization have to be kept in mind while making any future policies or working for the civil service, so that correct decisions can be arrived at concerning continuous reforms and future reforms in the banking sector.

Key Takeaways for UPSC Aspirants

  • Historical Context: The nationalization of banks in India occurred in two phases, first in 1969 and later in 1980, under the regimes of Prime Minister Indira Gandhi.
  • First Phase (1969): 14 major commercial banks were nationalized, holding a majority of India's deposits, to better align with social objectives like poverty alleviation.
  • Objective: The primary goals were to ensure the equitable distribution of credit, increase reach to rural and underbanked areas, and prevent concentration of wealth and economic power.
  • Second Phase (1980): An additional 6 banks were nationalized, further extending the government’s control over financial institutions and aiming at enhancing the banking sector infrastructure.
  • Impact on Economy: It led to substantial expansion of branches in rural areas, an increase in credit flow to priority sectors like agriculture and small industries, and contributed to the overall economic development.
  • Challenges and Criticisms: While nationalization increased financial inclusion, it also led to inefficiencies, higher non-performing assets (NPAs), and political interference in banking operations.
  • Reforms Post-1991: Following economic liberalization, financial sector reforms aimed at improving efficiency, fostering competition, and reducing NPAs were introduced to address the challenges posed by nationalized banking.
  • Legacy and Relevance: The nationalization of banks remains a landmark event that redefined the Indian banking sector's landscape, significantly contributing to financial inclusion and social development objectives.

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Nationalization of Banks UPSC FAQs

The nationalization of banks was proposed by Prime Minister Indira Gandhi, who played a pivotal role in implementing this policy.

The nationalization in 1949 refers to the nationalization of the Reserve Bank of India, which was the first major banking institution to be brought under state control.

The Bank of Hindustan, established in 1770, is considered India's first bank.

The Reserve Bank of India was the first bank to be nationalized in 1949.

The 14 banks nationalized in 1969 are: Central Bank of India, Bank of India, Punjab National Bank, Bank of Baroda, United Commercial Bank (now UCO Bank), Canara Bank, United Bank of India, Syndicate Bank, Indian Bank, Indian Overseas Bank, Bank of Maharashtra, Dena Bank, Union Bank of India, and Allahabad Bank.

In 1969: Central Bank of India, Bank of India, Punjab National Bank, Bank of Baroda, United Commercial Bank, Canara Bank, United Bank of India, Syndicate Bank, Indian Bank, Indian Overseas Bank, Bank of Maharashtra, Dena Bank, Union Bank of India, and Allahabad Bank. In 1980: Andhra Bank, Corporation Bank, New Bank of India (merged with Punjab National Bank in 1993), Oriental Bank of Commerce, Punjab & Sind Bank, and Vijaya Bank.
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