Why India would be well-advised not to mindlessly privatize its banks

Why India would be well-advised not to mindlessly privatize its banks

Sujay Rao Mandavilli

 

Let us begin this article by tracing the history of banks. The history of banking is thought to have begun with the first prototype banks that emerged in the ancient world, with merchants giving loans to farmers often in the form of grains or life stock, and traders who transported goods across regions. This was around four thousand years ago, in regions such as Assyria, India and Sumer. Several centuries later, both in ancient Greece and during the Roman Empire, lenders gave loans, while accepting deposits and performing the change of money. Most research carried out in the economies of ancient China and India also show evidences of money lending, and transactions were often carried out in or around temples, and other places of worship.

According to many scholars, the roots of modern banking began in medieval and Renaissance Italy, particularly around the Italian cities of Florence, Venice and Genoa. The Bardi and Peruzzi families dominated banking in fourteenth century Florence, gradually establishing branches in many other parts of Europe, as the concept of banking spread widely across the region both within Italy and across Europe. The most famous Italian bank was the Medici Bank, established by Giovanni Medici in 1397. The oldest bank still in existence is Banca Monte dei Paschi di Siena, which is headquartered in Siena, Italy, and which has been operating continuously since the year 1472. Until the end of 2002, the oldest bank still in operation was the Banco di Napoli headquartered in Naples, Italy, which had been operating since 1463. Following the acquisition of the bank at the end of 2002 by the Sanpaolo IMI group, in 2003 the bank changed its name to "Sanpaolo Banco di Napoli". In 2018, the Bank of Napoli was officially closed and integrated into the "Intesa Sanpaolo"

Later, a number of important innovations took place in Amsterdam during the Dutch Republic in the seventeenth century, and in London since the eighteenth century. London gradually became the financial centre of much of the western world, though it has since been eclipsed by other cities in the west, and later, Asia. Many banks collapsed during the Great Depression, and the banking system as such was not bullet-proof reliable. During the second half of the twentieth century particularly, rapid and impressive advances in telecommunications and computing caused major changes to banks' operations and let banks dramatically increase in size and geographic spread. The 2008 financial crisis also led to many bank failures, including some of the world's largest banks, and this unfortunate event provoked much debate about bank regulation.

Let us now trace the history of banking in India. Seals were present in the Indus valley civilization, and we do not know their use for certain, though hypotheses persist. Perhaps, they served administrative and trading functions, though some scholars offer other explanations. In ancient India there are evidences of loans from the Vedic period beginning around 1750 BCE. Later during the Maurya dynasty beginning in the fourth century before Christ, an instrument called Adesha was in use, which was an order on a banker desiring him to pay the money of the note to a third person. This corresponds to of a bill of exchange in the manner that we understand it today. Merchants in Ancient India also began to offer loans and advances to each other, and trade and commerce began to spread widely.

Modern banking in India originated in the middle of the eighteenth century, when India came under the rule of the British East India Company. Among the nations first banks were the Bank of Hindustan, which was established in 1770 and liquidated around the period 1829–32; and the General Bank of India, established in 1786 but failed in 1791. The largest and the oldest bank which is still in existence India is the State Bank of India . It originated as the Bank of Calcutta in 1806. In 1809, it was renamed as the Bank of Bengal. This was one of the three banks founded by a presidency government, the other two being the Bank of Bombay in 1840 and the Bank of Madras in 1843. The three banks were merged in 1921 to form the Imperial Bank of India, which upon India's independence, became the State Bank of India in 1955 with the passage of the SBI Act. For many years, the presidency banks had acted as quasi-central banks, as did their successors, until the Reserve Bank of India was established in 1935, under the Reserve Bank of India Act, 1934. This became India’s central bank, and remained a largely independent and autonomous entity and body.

Nationalization of banks refers to state ownership of banks in terms of equity. In 1960, the State Banks of India was given control of eight state-associated banks under the State Bank of India (Subsidiary Banks) Act, 1959. However the merger of these associated banks with State Bank of India went into effect on 1 April 2017. On the twentieth of July 1969, the Government of India effected its first tranche of nationalization by nationalizing fourteen major private banks; one of the big banks nationalized was the Bank of India. In April 1980, six more private banks were nationalized. These nationalized banks were the biggest in India in terms of both operations and lending. The nationalization of banks in India was an epochal event that redefined the Indian banking landscape. Though it brought several benefits, it also faces some criticisms. For one, nationalization of banks helped achieve India’s economic goals post-independence, and helped it achieve rapid industrialization. It also helped banking penetrate to smaller towns and rural regions, and made the banking system highly stable and free from nefarious private activities. Other benefits of the nationalization of banks in India were enhanced social welfare, reorientation of lending priorities, erosion of the power of private monopolies and greater financial inclusion of the poor.

Criticisms of nationalization of banks have included allegations of sloth, bureaucracy, political interference, and inefficiency. Some people argue that there was a lack of competition, though this has mostly not been the case.  Of late, there have been attempts to privatize Indian banks. The privatization of banks in India involves reducing the government's majority stake in nationalized banks in order to allow private investors greater control and ownership, as was announced in the Union Budget of 2021-22 based on the earlier 1991 Indian economic reforms. The stated goals of privatization were the need to improve efficiency, reduce the government's financial burden, foster healthy competition among banks, and attract private investment into the banking sector in order to meet economic growth needs. The zeal with which governments privatized banks appears to have reduced, and there appears to be some form of introspection taking place not withstanding renewed efforts in 2025.

There is a wide variation of rules in different countries as far as the banking system is concerned. The US banking system is generally seen to be weak in most areas, and the US is generally driven by conservative right-wing ideology. The US banking system is a dual system with federal and state-chartered institutions overseen by a range of regulatory bodies, led by the central bank, the Federal Reserve System. The Federal Reserve conducts monetary policy, regulates banks, maintains financial stability, and provides financial services to the government and other institutions. Key players include the Federal Reserve Board of Governors, the twelve Federal Reserve Banks, and the Federal Open Market Committee (FOMC). Deposit insurance, managed by the FDIC, protects consumer deposits, and the structure includes a variety of institutions like commercial banks, credit unions, and savings banks. 
Weaknesses in the US banking system include vulnerability to high-interest rates causing unrealized losses on assets and loan defaults, exposure to uninsured depositor runs, risks from commercial real estate loans, cybersecurity threats, regulatory burdens, and competition from FinTech. Additionally, challenges include managing non-performing loans, the cost of legacy systems, potential for unethical behavior, and the economic fallout from geopolitical tensions. 

The American banking system significantly contributed to the Great Depression through widespread bank failures, bank runs, and a contracting money supply, exacerbated by Federal Reserve policy that failed to act as a lender of last resort. Over nine thousand banks closed between 1930 and 1933 which was the peak period of the Great depression, leading to a massive loss of public deposits and creating a vicious cycle of declining consumer spending and business investment due to the lack of available credit. The lack of effective regulation in lending, coupled with a belief in maintaining the gold standard, led the Fed to raise interest rates and reduce the money supply, worsening the deflationary spiral and the economic collapse. Of late, the financial position of many Indian banks has improved considerably, and customer service has also improved. We must take in the best aspects of other banking systems, not the worst ones. India’s bank nationalization effects have provided many benefits to the banking public, and to the economy. In summary, India should make its banking system stronger, not privatize banks mindlessly. Of course, private banks can continue to operate under strict government regulation.