Few people understand this but the banking problem in India after 1947 has always been a political one. So it is a mistake to treat it as an economic or commercial problem.
At the heart of the politics lies rural credit, and its origins go back at least 500 years. If you read India’s economic history you will find that in the 1950s, rural credit and irrigation, rather than technology and better practices, were seen as being critical.
The policy was this: while irrigation would be taken up by the central and state governments the problem of credit to farmers was intractable. There was broad agreement in the country that commercial banks
For a decade cooperative banks
were created and promoted. But they were soon captured by local politicians and landlords. By the end of the 1950s, it was clear the idea had failed. The lack of expertise, which continues to be a major problem in PSBs, was also to blame.
By the mid-1960s, the RBI had become sufficiently disillusioned and began to wonder, along with the Congress party’s Left, if it would not be better to force commercial banks
to go rural rather than to set up a completely new network of rural cooperatives.
It was in this environment that an old debate---social control of banks vs. outright nationalisation---cropped up once again. By the mid-1960’s, in the wake of the two droughts of 1965 and 1966, it was raging in earnest.
The issue was, in some senses, simple: who would control the banks, private individuals pursuing a profit motive somewhat tempered by obligations to society or the government pursuing social justice somewhat tempered by the pursuit of a profit motive?
No one at the time had any clear idea how either option would actually work out in practice. The demand for credit was huge. The savings rate, at about 15 per cent, was inadequate. The banks, with their responsibilities to shareholders, were very narrowly focused. The government, aware of its larger role, was increasingly desperate. The only thing missing was clarity.
It is futile to pretend that the private sector banks
were blameless. Both in the matter of industrialisation and the spread of banking, they had not come up to expectation.
The RBI and the government had for long been convinced that they were not interested in expanding banking beyond urban areas. In 1961, for example, there were just 5,100 branches in India, of which over 99 per cent were in urban areas, or very close to them.
Under pressure from the RBI, by the end of 1964, around 700 more had been added. But that still wasn’t enough because hardly any of these were in rural areas.
In 1965, the RBI liberalised its branch licensing policy but insisted that the majority of new branches had to be in rural areas. The new policy envisaged 450 new branches. It didn’t work.
A frustrated L. K. Jha told a meeting of bankers in 1967 that he was all for slowing down branch expansion in urban areas. The bankers told him privately that they agreed but would he also then impose the same restrictions on foreign banks?
Jha replied that foreign banks ‘were obliged to confine themselves to towns’ in order to protect their profits.
The foreign banks posed a peculiar problem. After 1962 they had been restricted to the three main port towns and in any case were unwilling to go anywhere else.
Even so, the Indian banks were complaining that they were being discriminated against and that the foreign banks should be restrained or forced to go to rural and semi-urban areas. The foreign banks were saying that it was they who were being discriminated against because they felt they were not being allowed to open more branches.
In the end, L. K. Jha settled the debate by pointing out, firstly, that foreign banks helped raise foreign exchange and, secondly that whereas they had been allowed to open only 43 offices, Indian banks had opened nearly 2,400.
A new era
As the 1960s dragged on with their unending string of disasters, public, political and academic opinion
began to veer towards nationalisation, gradually at first and then with increasing speed. Importantly, it was not driven by leftist ideology; instead it was seen as a way of ending the sense of drift in the country.
The people were looking for a decisive leader in much the same way as they were in 2014 when Narendra Modi appeared on the scene, someone who would actually lead.
Indira Gandhi, after a hesitant debut that lasted all of three and a half years from January 1966 to July 1969, suddenly burst forth in all her political glory when she nationalised 14 banks.
In one fell swoop, the DOS of the country changed, not just in politics which moved from party to person but also the economy which moved from private hands to state.
Excerpted from my book, Dialogue of the Deaf: RBI and the Government.