Nationalization of the banking sector in India is one of the most important chapters of the Indian Economy. On January 1, 1949, the Reserve Bank of India (RBI), which regulated the nation's central banking system, was nationalized. Immediately after the independence, with the first five-year plan in 1951, the government adopted a socialist path and required significant financial assistance from the banking industry. Up until that point, all Indian banks were private and located solely in large cities. They were all governed by industrialists, and between 1951 and 1968, the percentage of credit extended by private banks to the industrial sector doubled from 34% to 68%. While the share of agriculture in the entire credit was less than 2%.
The nationalization of banks happened at a time when the Indian economy and politics were going through a very bad phase. The Indo-China War of 1962 and the Indo-Pak War of 1965 created immense pressure on public finances. At the same time, successive years of drought resulted in a shortage of food. Population was growing exponentially but the economic growth was very low. Under these circumstances, Prime Minister Indira Gandhi decided to nationalize banks. The objective was to free banks from private monopolies, promote and mobilize savings, create financial inclusion, develop rural areas, advance agriculture, and promote overall social equality. Subsequently, on 19th July 1969, the Indian government decided to nationalize 14 of India's major private sector banks. Later In 1980, the government took control of another 6 banks.
Consequences of nationalization of banks:
A rise in public trust in banks: Customers' confidence in the security of their money increased as a result of nationalized banks. As a result, the amount of capital placed in banks increased manifold.
Rural development and the mobilization of funds: Earlier banks were limited to profitable metropolitan areas, but after nationalization, they also entered remote and rural areas. These savings were mobilized by the government as a result of the branches' quick expansion.
Development of Priority Sectors: The extension of advances to priority sectors following the nationalization of banks is a significant shift. To achieve this, the banks developed several programs to lend money to small borrowers in priority industries such as retail commerce, small businesses, small-scale manufacturing, agriculture, etc.
Low Profitability: One of the main problems with banking following nationalization is that the nationalized banks either lose money or see their dividends decline. After nationalization, the commercial banks' profits (which were quite substantial in the 1950s and 1960s) decreased significantly.
Low Efficiency: The banking system now operates with a bureaucratic mindset as a result of nationalization. Nationalized banks frequently exhibit rigid conformity, excessive delays, lack of initiative and accountability. Thus, consequently, these banks are now less efficient.
Growing NPAs: The government's pressure at the top to implement even loss-making schemes, or fully waive loans in exchange for electoral advantages has created an NPA crisis in public sector banks. Public banks have witnessed many scams also. Also, political interference and bureaucracy in the functioning of the banking system have further worsened the NPA problem.