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  • Manvi Priya

Nationalization to Privatization: A Journey of Banking Sector 

Manvi Priya  

BVDU, New Law College, Pune (Maharashtra)

Nationalization to Privatization: A Journey of Banking Sector


A bank is a financial institution authorized to accept deposits and grant loans. A good and efficiently managed banking system can positively change the face of the economy of a country. It is necessary to meet the needs of time and the market to stay relevant and competitive and in pursuit of that, change is an accepted move but if the change is not executed in an ordered manner the result could be contrary. At present there are 12 public sector banks, and 21 private sector banks are operating in India.  In public sector banks the government is the major stakeholder and in private sector bank private entity have major vested interest. To maintain the free flow of the capital in the market, bank performance is a lookout.  In recent times, government inclination towards privatization was at peak to eliminate the non-performing assets and promote an efficient mechanism.  It was seen PSUs are not performing optimum to keep up with the pace of dynamic market and consequently economy is the sufferer, so many PSUs were either privatized or merged. 

History of Nationalization of Banks in India

In 1969, the then Prime Minister and Finance Minister of India nationalize fourteen private banks and brought it under the purview of the government. The second phase of nationalization took place in 1980 when six more banks were nationalized. It was done to promote the concept of and the then government manifestation of ’Socialism’ and removal of poverty. Increasing the outreach of banks to rural areas and ensuring rural people's presence in the important tool of economy was the key reason. India is the land of agriculture and a major contributor in the country’s GDP so overlooking it was a mistake that government avoided making. One of the key importance of Nationalization was that it increases the faith of public in the banking sector as for them at time it was an alien concept as rightly said it open the path of ‘’from class banking to mass banking’’. Centralized management caters to the public interest more than profit making.

Now, market is dynamic in nature as it changes relevant method to serve its demand is introduced same happen in 1991, when New Economy Policy was introduced by then Finance Minister of India Dr. Manmohan Singh under the guidance of then Prime Minister PV Narsimha Rao on 24th July 1991.

LPG Model and Reforms followed in Banking Sector.

During the 90s, the government expenditure was more, and income generated was less. There started to arise the problem of Balance of Payment. By the start of 1991, India faces major economic crisis its central bank refuse to credit due to insufficiency of funds. Moreover, the foreign reserve fund was not sufficient even to last for a fortnight. Cherry on the cake was rising prices of essential goods and all such unavoidable factors led to the introduction of the New Economic Policy, 1991. With this Indian economy underwent Structural reforms in the form of –Privatization, Liberalization and Globalization. The model of LPG brings reforms in the banking sector like:

a.     Do away with the complex system of interest rate control.

b.     Prior permission of Reserve Bank of India for granting big loans and decline in requirements to invest in government securities.

c.      Introduction of banking norms like capital adequacy requirements.

d.     Bringing healthy competitions in the banking sector and expansion of foreign banks.

e.     Transparency in credit transactions helped meet global standards.

Committee Recommendations on Privatization

  • First Narasimham Committee– Committee concluded that, the foreign banking policy is in harmony with government policy and the entry of foreign banks in the domestic market will be beneficial for the country as it will give healthy competition bank that will increase its efficiency. Also, upgradation of technology in the banking sector.

  • Committee on Banking Sector Reforms– Narasimhan was the chairman of this committee. The committee recommended modifying the banking system critical to its growth by tightening capital adequacy, income generation and provisioning norms. Further it suggested less government stake in the equity of nationalized banks and State Bank of India stake be brought from 51% to 33%. The committee supported bank privatization.

  • Verma Committee Report– The committee recommended closing down weak banks. Weak banks according to the committee are those banks that have high non-performing assets. In rural areas weak banks are mostly prevalent and if they are allowed to function in the economy it will hamper the efficiency of other banks also. 

Thus, all the committee discussed agreed on restructuring the banking sector. The government also considers suggested measures. These committees were formed during the late 90s after the introduction of the LPG model in 1991. 

RBI Guidelines for Newly Privatized Banks

As a part of reforming the sector in financial services, in January 1993, the RBI issued certain guidelines for providing licenses for new banks in the private sector. It has revised its guidelines after 8 years in 2001. They are as follow:

  1. Paid-Up Capital– The new banks must maintain a minimum of capital paid up of Rs 100 crores. The initial capital should be raised to Rs. 300 crores within 3 years of start of business. The final capital must be approved by the RBI. 

  2. Promoters Contribution– The promoters' contribution should be a maximum of 40% of the paid-up capital of the bank. The contribution of 40% will be locked for 5 years from the date of licensing.

  3. Foreign Investment– The participation of non- resident citizen of India shall have a maximum equity of 40%. In the case of foreign banking co-promoter equity participation will be confined to 20% with an upper limit of 40%.

  4. Banks Promoted by Large Industrial Houses– Individual companies are allowed to take part in the equity of new banks up to 10% as directly or indirectly they have shares in the bank, and this applies to all large business house who have interconnected companies.

  5. Constitutional Obligation– The constitution of India seeks to promote the social inequality by ensuring that there is an equal opportunity for all, and the citizen should be safe and secure.

  6. Capital adequacy ratio– The bank must maintain the minimum capital adequacy of 10% on a continuous basis from the start of its functioning. 

Notable Causes of Privatization.

-        To abridge the government burden

-        To enhance the competition in the market

-        To increase the efficiency of public finances

-        To ease the infrastructural growth

-        Accountability to shareholders

-        To reduce not required interferences

-        More organized labor force

-        To reduce the burden of non-performing asset

-        To check the corruption

Privatization can be categorized into three parts 

  1. Delegation– Private entities handle the delivery of products and services government just holds the responsibility. 

  2. Disinvestment– Government has no responsibility. This is usually done so that the public sector units can be financially stable and modernized. 

  3. Displacement– The expansion of the private sector eventually led to the displacement of the government entity.  

Advantages of Privatization of Banks

  1. Private banks have emerged as a credible alternative to public banks. In recent years it has been seen that public sector banks are not contributing to extend it is needed.

  2. Reserve Bank of India has more regulatory power with respect to private banks than public banks as public banks have government interferences. As an abled authority in the banking sector RBI will help banks to prosper.

  3. Except State Bank of India most of the public sector banks have stood back to private sector banks in terms of performance during the last decade. 

  4. The current fiscal position of the Union Government is not strong enough to provide huge sums for recapitalizations and keep on sustaining sick PSBs.

  5. The privatization of the bank will have a positive impact at a macroeconomic level as it will help bring stability.

  6. Private sector banks work on the agenda to increase profit and to remain relevant in the market. They keep on upgrading the technology that comforts the customers.

Shortcomings of Privatization of Banks 

  1. Increased costs and fees for customers– Private entities work with the motive of generating profits this leads to an increase in service costs for customers. It is widely observed that bank services become less affordable after privatization.

  2. Short–term profit orientation– The 2008 global financial crisis highlights the severe impact of short-term profit orientation as private banks involve in risk taking.

  3. People’s Trust– The trust factor plays a significant role in making an investment by the people.

  4. Concentration of power and market dominance– Concentration of power can lead to establishment of monopoly in the market, and this can further increase the distrust of mass.

  5. Neglect social objectives– Government owned sectors focus more on social objectives than on profit making. On the other hand, the motive of private entities is profiting maximization.

Privatization of bank is not panacea to PSBs inefficiencyii 

The wave to privatize the bank catalyze back in 2018 with the report of fraud of $2 billion (about $6 per person in the US) at the Punjab National Bank.  

There are some arguments presented by the experts in favor of privatization of banks with caution.

First, the rise in fraudulent activities reflects poor risk management and regulatory fiasco. Even if banks are privatized there still are fair chances of fraudulent acts if the governing and regulatory mechanism is not improved.

Secondly, it has been contended that the managers stay complacent with the factor of government ownership that in any other case government will come to rescue. But should ownership be the only criteria for government intervention?  If PNB or State Bank of India were privately owned, would the state allow these banks to fail?

It is also argued that privatization of banks will increase competition and better management in the banking sector but again the question lies how change in ownership will bring change if number of participants remain same.

Finally, it must be remembered that state owned banks in the economy are largely based on social objectives – to meet the needs of the most vulnerable section of society, and private sectors are more profit oriented, so a balance need to strike on this matter.

Public or Private Sectors Banks can be equally good or bad. Mere transfer of ownership will not bring huge change on ground unless it is executed cautiously, and the objective is not lost. The functioning of public banks should be more autonomous and devoid of unnecessary interference. Moreover, RBI power regarding public sector banks should also be increased to ensure it is functioning under expertise not bureaucracy. 

Like privatization, in recent years the government has made mergers of public sector banks to increase its efficiency. The objective behind the same is to:

  1. To reduce financing costs and increase operational effectiveness

  2. To ensure significant presence of bank at national level and increase its global reach

  3. Merger will increase the potential of new banks

  4. Reshaping PSBs will help to achieve the goal of $5 trillion economy

  5. Increased ability to take risks and credit

  6. Efficiency in service delivery mechanism

Privatization of PSBs: An Overviewiii 

Failing to plan is planning to fail’’, any move by the government in the banking sector not just impacts economy at large but to individual as well.  Government while doing privatization should be cautious. A proper report by the expert committee should be formed to direct the way in which public sector banks should be privatized. The major lookout while doing privatization would be to check it is not creating regional imbalances and public distrust. An informed and analyzed roadmap will help the objective of privatization get acceptance in the market.

The next argument is regarding the pace of privatization. It is obvious that private sector banks have outshined the public sector banks in terms of performance and effectiveness. For government to reach their true market potential required to handover the public banks in the hands of private entity.

In public sector banks there are dual governance between RBI and Government of India as a result there lacks transparency and accountability. In the situation of ineffectiveness, it becomes difficult to ascertain the cause, whether it is government interference or regulatory body underwork responsible. If mostly the banks would be privatized RBI would get more autonomy and accountability with respect to banks as a regulator.

The next important point to be looked as to which bank should be privatized first. Criteria need to be ascertained to privatize banks on basis like its performance in the market, its asset value, its scope on getting merged, etc., would help government to take informed decisions. 

There are socio-economic factors that need attention before privatization. A large sum of people from SCs, STs and OBCs acquire prominent positions in the public banks by means of reservation. If banks are privatized rapidly without considering this, it will impact them so a thought in this direction is required.

Government must not just transfer the ownership and take the backseat but must actively keep a check on the functioning of banks under private players so that it does not become the monopoly of a few and make a road back, ‘’from mass banking to class banking’’.  

The Constitution of India promotes economic justice and banking is a crucial mode through which it can be ensured. While making development the objective must not be forgotten. With changing times not objective but method of its execution should be changed otherwise it will have deleterious impact in long run. A decision is a wise one when it covers all possible outcomes and prepares an alternative if things go otherwise of the planning. 

Conclusion and Way Forward 

A good banking system is the backbone of a good economy. Transferring the ownership of the banks will not alone going to have sea facing change on the economy unless the objective for which transfer was made is standby. It is wrongly believed that privatization of banks will bring too much efficiency in the banking sector, but this is not the case even in the private banks where there are disproportionately high NPAs (non-performing assets). Ours is a developing nation and for long term goals it is desirable to attract new technologies and reforms to the banking sector but not at the cost of people’s welfare. Government, while transferring ownership, should make sure that it has a say in the privatized bank. 

One major factor that cannot be ignored while privatizing banks is gathering mass faith in the system and how the process will be beneficial for them and the economy in the time to come. Public distrust can make history repeat. Privatization of banks is not the last resort to increase efficiency in the banking sector but a sincere lookout on why there is inefficiency. Because if there is fallout in the mechanism then it can follow in private bank too. A better approach could be that before privatizing the bank a better setup of the system to accept it should be made. 



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