Nationalized BanksIndian Banking and Currency System

Asst. Prof. Nayan Vaghela

Phases of Nationalization Process The first phase of nationalization began with the nationalization of

Imperial Bank of India, under the State Bank of India Act, 1955. the State Bank of India Came into existence on 1st July 1955. it has seven subsidiaries. It holds the dominant market position among all the commercial banks. It is the largest commercial banks with 19194 and 63 foreign branches.

In second phase, the government decided to nationalize 14 major commercial banks on 19th July, 1969. All commercial banks with a deposit base over Rs.50 crores were nationalized. It was considered that banks were controlled by business houses and thus failed in catering to the credit needs of poor sections such as cottage industry, village industry, farmers, craft men, etc.

In third phase, 6 commercial banks in the private sector were nationalized on 15th August 1980. in 1993, Bank of India was merged with Punjab National Bank, hence the number of public sector banks other than the State Bank of India and its seven associate banks declined to 19. the total number of branches of Nationalized Banks in India as on 31st march 2012 was 48822.

Objectives of Banks Nationalization:

1. Social Welfare: in order to achieve the objectives of economic and social welfare, it was essential that the ownership and control of country's strategic sectors .should be in the hands of the state. As the financial institution like banks are the most important levers of the attainment of social objectives, the nationalization of banks was considered as significant step.

2. Controlling Private Monopolies: Prior to nationalization many banks were controlled by private business houses and corporate families. It was necessary to check these monopolies in order to ensure a smooth supply of credit to socially desirable sections.

3. To Curb the Evil of Inter-locking of Directorates: As the directors of the banks were connected with one or the other industrial groups the banks under their control used to make unsecured advances to them. Loans were sometimes given to even extremely weak financial concerns if the directors had their interest in them; likewise resources of the banks were utilized by the directors to promote their personal interest. All these meant misuse and misdirection of the saving of the community.

4. Allocation of resources in Accordance with Plan Priorities: It was found that many a times bank advances did not confirm to the priorities laid down in our five year plans. While liberal advances were made to low priority industries the credit need of high priorities were practically starved. This resulted in the distortion of the pattern of investment. In other words, bank had failed to be guided by the positive social objectives of our planning process. It was argued that the private control of commercial banks in a planned economy was anachronism which had to be an obstacle to the achievement of plan objectives.

5. Priority Sector Lending: In Nationalization, the agriculture sector and its allied activities were the largest contributor to the national income. Thus these were labeled as the priority sectors. But unfortunately they were deprived of their due share in the credit. Nationalization was urgently needed for catering funds to them.

6. Reducing Regional Imbalance: In a country like Nationalization where we have an urban-rural divide; it was necessary for banks to go in the rural areas where the banking facilities were not available. In order to reduce this regional imbalance nationalization was justified.

7. To prevent the misuse of the Funds: t was also pointed out that in many cases, bank credit instead of being used for genuine productive purpose was diverted to hoarding, profiteering, speculation and other anti-social activities. This created artificial scarcity of goods and commodities in the economy. Bank Nationalization was sought to prevent the misuse of bank funds.

Achievements of the Nationalized Banks:1. Development-oriented Banking: Historically, Indian banks were mainly

concerned with the growth of commerce and some of the traditional industries such as, cotton textile and jute. The banks were concentrated in the big commercial centers. They mostly granted short-term commercial loans. They were unwilling to venture into new fields of financing. But after nationalization of banks, the concept of banking has widened from acceptance of deposits and mere lending to development oriented banking. Banks are increasingly catering to the needs of industrial and agricultural sectors. From short- term lending, banks have been gradually shifting to medium and even long-term lending. From well-established large industries and business houses, banks are positively shifting to assisting small and weak industrial units, small farmers, artisans and other neglected groups of people in the country. They have adopted the Lead Bank Scheme. Under this scheme, all the districts of the country are allotted to some bank or the other. The lead bank of district is actively engaged in: Opening bank branches in all important localities. Providing maximum credit facilities for development in the district, and Mobilizing the savings of the people in the district.

2. Branch Expansion: Rapid economic development pre-supposes rapid expansion of commercial banks. Initially, the banks were conservative and opened branches mainly in cities and big towns. Branch expansion gained momentum after nationalization of top commercial banks and the introduction of “Lead Bank Scheme.” The Lead Bank Scheme has played an important role in the bank expansion Program. The number of branches of all scheduled commercial banks increased from 8,260 in 1969 to 1,02,343 in march 2013. Thus within 44 years after bank nationalization, there was over 900 per cent increase in the number of branches. There had been a significant increase in bank branches in the rural, under banked and unbanked areas. The number of branches in rural areas increased from 1860 in 1969 to 37,953in 2013. With the progress of branch expansion Program, the national average of population per bank office has declined from 63,800 to 15,000. M. Gopalkrishnan says “the single striking feature of the post-nationalization banking scene is the rapidity with which the branch network has multiplied itself. The rate of branch expansion has been unparalleled any where else in the world.” Thus, the overall growth of bank branches in the last 30 years has been remarkable in its geographical coverage and removal of regional imbalances in the country.

3. Expansion of Bank Deposits: Since nationalization of banks, there has been a substantial growth in the deposits of commercial banks. Thus bank deposits had increased by 150 times. Development of banking habit among people through publicity, extensive branch banking and prompt service to the customers led to increase in bank deposits. To attract deposits, Indian banks have introduced many attractive saving schemes. To attract deposits from widely scattered areas, mobile bank’s branches have been introduced by a number of banks.

A number of banks have started evening branches, Sunday branches for the benefit of their customers. Apart from the quantitative increases in deposits, there has been an impressive qualitative shift. The number of small account holders with the banks has been increasing day-by-day. Aggregate deposits are composed to time deposits and demand deposits. Earlier there was predominance of demand deposits. Now there is predominance of time deposits. The ratio of time deposits to total deposits has been increasing.

4. Credit Expansion: The expansion of bank credit has also been more spectacular in the post-bank nationalization period. At present, banks are also meeting the credit requirements of industry, trade and agriculture on a much larger scale than before. Credit is the pillar of development. Bank credit has its crucial importance in the context of development and growth with social justice.

5. Investment in Government Securities: The nationalized banks are expected to provide finance for economic plans of the country through the purchase of government securities. There has been a significant increase in the investment of the banks in government and other approved securities in recent years.

6. Growing Importance of Small Customers: The importance of small customers to banks has been growing. Most of the deposits in recent years have come from people with small income. Similarly, commercial banks lending to small customers has assumed greater importance. Thus banking system in India has turned from class-banking to mass-banking.

7. Advances to Priority Sectors: An important change after the nationalization of banks is the expansion of advances to the priority sectors. One of the main objectives of nationalization of banks to extend credit facilities to the borrowers in the so far neglected sectors of the economy. To achieve this, the banks formulated various schemes to provide credit to the small borrowers in the priority sectors, like agriculture, small-scale industry, road and water transport, retail trade and small business. The bank lending to priority sector was, however, not uniform in all states.

It was quite low in many backward states like U.P., Bihar and Rajasthan. Under the new banking policy stress is laid on the weaker and under-privileged groups in the priority sector “weaker sections” refer to all persons who became suppressed, depressed and oppressed because of socio-political, socio-economic or socio-religious reasons. The concept of profitability has been substituted by “social purposes” with regard to lending to weaker sections of the society. Quantitatively, banks have done well in priority lending. But overdues and bad debts have been a serious problem faced by banks in respect of advances made to the weaker sections of the society. There is always the problem of ensuring the effective end use of the loans given to the priority sectors.

8. Social Banking – Poverty Alleviation Program: Commercial banks, especially the nationalized banks have been participating in the poverty alleviation Program launched by the government.

Differential Interest Scheme: With a view to provide bank credit to the weaker sections of the society at a concessional rate the government introduced the “Differential interest rates scheme” from April 1972. Under this scheme, the public sector banks have been providing loans at 4% rate of interest to the weaker sections of the society.

Integrated Rural Development Program (IRDP): This is a pioneering and ambitious Program to rectify imbalances in rural economy and also for all- round progress and prosperity of the rural masses. Under this Program banks has assisted nearly 1.8 million beneficiaries during 1997-98 and disbursed a total amount of Rs. 1990 crores as loan. Out of the beneficiaries, over 1 million belonged to scheduled castes and scheduled tribes and 0.7 million were women. Other important scheme introduced by the government of India and implemented through the banking system includes self-employment scheme for educated youth, self-employment Program for urban poor, and credit to minority communities.

9. Innovative Banking: In recent years, commercial banks in India have been adopting the strategy of “innovative banking in their business operations.” Innovative banking implies the application of new techniques, new methods and novel schemes in the areas of deposit mobilization, deployment or credit and bank management. Mechanization and computerization processes are being introduced in the day-to-day working of the banks.

10. Globalization: The liberalization of the economy, inflow of considerable foreign investments, frequency in exports etc., have introduced an element of globalization in the Indian banking system.

11. Diversification in Banking: The changes which have been taking place in India since 1969 have necessitated banking companies to give up their conservative and traditional system of banking and take to new and progressive functions. The government had been encouraging commercial banks to diversify their functions. As a result, commercial banks have set up merchant banking divisions and are underwriting new issues, especially preference shares and debentures. There are now eight commercial banks which have set up mutual funds also. Commercial banks have started lending directly or indirectly for housing. Venture capital fund is also started by one public sector bank. State Bank of India and Canara Bank have set-up subsidiaries exclusively for undertaking “factoring services.” In future all commercial banks can be expected to diversify their functions and adopt new technologies.

Problems and Constraints of the Public Sector Banks:1. Problems pertaining to Branch Expansion:

There has been expansion of bank branches in India, which accounts almost 7,5 fold increase in the number of bank branches over last decade.

The share of public sector banks in total increase in the bank branches is around 70%.

In 1969, the number of rural branch of the bank was 22 which has increased and reached to 36.1% in 2011.

The average population per bank in India at the end of June, 2011 was 14000 as against 4000 in England and Canada, 7000 in USA and 5000 in Germany.

It has been observed that the public sector banks are more concerned to the fulfilment of the physical targets, which should be avoided.

The rural bank branches are starving for trained and skilled staff, which hamper the business potentials of the banks.

A lack of report has been found between the bank staff and the villagers. There has been time dispute between the farmers and the staff for banking hours.

The observation of the branch expansion process in India reveals that the expansion process has mainly been seen in the considerably developed regions of Western and Southern India while the poor and backward states have derived less benefit.

2. Problem Pertaining to Deposit Mobilization: Rise in the money income of the people, Increase in the number of bank offices, Special efforts for deposit mobilization by the scheduled banks by

introducing innovative schemes for savings and offer of various types of incentives to the customers; led an increase in the amount of bank deposits.

Only 25% of the total deposits belongs to rural areas. Lack of adequate bankable and creditworthy development projects in

rural area leads to the diversion of rural deposits to the urban areas. The nationalized banks are also facing competition from some financial

institutions as they are providing more interest on deposits than that of nationalized banks.

3. Problems pertaining to Credit: Total bank credit in 1969 was 3035 cr. And increased to 29,96,655 cr.

In 2011. Prior to bank nationalization, a substantial part of bank credit was

given to trade, commerce and industry which formed about 86%of the bank credit, while the share of agriculture was hardly 2%, credit to small industries, self employed and retail traders was neglected.

Post nationalization there has been fundamental and qualitative change has taken place in composition of bank credit.

Under social banking credit on a preferential basis to the priority sectors of the economy and to the weaker section of the society has been given.

The priority sectors mainly includes:

a) Agriculture

b) Small scale industries

c) Small business and retail trade

d) Small road and water transport operations

e) Professional and self employed persons

f) Export sector

g) Education and housing loans. In the process of expansion of bank credit, following problems have

evolved:

a) Small and marginal farmers have derived relatively less benefits from banks.

b) Lack of coordination between the credit activities of nationalized banks and other institutions engaged in the similar task.

c) Lack of physical infrastructural facilities and marketing arrangements.

d) Lack of up to date land records, competition from private lending agencies, small and fragmented holdings leads to difficulties in providing credit to small farmers.

e) Lack of effective supervision on end use of credit.

f) High proportion of overdue due to poor recovery of loans.

4. Problem of Low Efficiency: The quality of customer services has been deteriorated in the post

nationalization period. Staff indiscipline, lack of devotion, red tapism, corruption, malpractices,

neglect of duty, lack of initiative and quasi decisions all have impaired the smooth working of public sector banks.

5. Frauds and Robberies: During the calendar year of 2000, commercial banks reported 3072 cases

of frauds involving an amount of 679,52 cr, in addition 8 cases of frauds involving an amount of 1,59 cr. Were reported in the overseas branches.

The central vigilance commission has to be more alert and security arrangements in banks have to be upgraded in co-ordination with the home and police departments of the concerned state governments.

6. Low profitability of the Public Sector Banks: 27 public sector banks had shown a net profit of Rs. 44901 cr. In 2010-11

(0.85% of total assets) 23 old private indian banks was having 3102 cr. Of net profit (1% of the

total assets) 8 new private banks were with 1.34% of total assets as net profit. 42 foreign banks were with 1.57% of the total assets as net profit.

The causes of low profitability of the public sector banks were;

1. Rapid branch expansion

2. High cost of establishment

3. Inadequate training

4. Concessional finance

5. Lack of cost consciousness

6. Inadequate recovery and overstaffing

7. Increase in Non-performing assets.

7. Politicization of Banking Operations: Political interference in the banking operations, particularly in the case of

public sector banks has been held responsible for wide spread defaults. The Agriculture Credit Review Committee had observed in 1989 that

commercial banks in India are overcontrolled, overregulated and over managed by the central government.

The committee had noted that in respect of rural loans, a large number of beneficiaries are identified not by banks or even by government agencies but by the functionaries of political parties.

This has to be checked and the banks should be freed from political interference.

8. Non-Performing Assets (NPAs) of Banks: Banks earn profits out of the Loans and Advances. However quite a high

percentage of their advances are not recovered; neither the interest nor the principle amount. It adversely affects the earning of nationalized and other banks.

Banks as well as RBI have taken many steps to recover their NPAs. An ordinance is promulgated in order to empower them to recover their dues. It has become an Act called ‘Securitization Act’ in 2002. The banks have got wide powers under the Act to enforce recovery of NPAs.

From the year 2003 it has been decided to extend the benefits of this act to co-operative banks as well. It is expected that this act will go a long way in tackling the problem of their NPAs.

Non-Performing Assets: Meaning: An asset becomes non-performing when it ceases to generate

income for the bank. A non-performing asset is defined as a credit facility in respect of which the interest and/or instalment of principal has remained ‘past due’ for a specified period of time. Interest and/or instalment of principal remained overdue for more than

90 days in respect of a term loan. The account remains ‘out of order’ in respect of over draft/ cash credit. The bill remains overdue for a period for more than 90 days in the case

of bill purchased and discounted. Interest and/or instalment of principal remains overdue for two harvest

season but for a period not exceeding two and a half year in the case of an advance grated for agricultural purposes.

Any amount to be received remains overdue for a period of more than 90 days in respect of other accounts.

Classification: Banks are required to classify non performing assets further in to the following three categories according to the period for which the assets has remained non-performing and the responsibility of the dues: Substandard and assets: Which has remained NPA for a period less than

or equal to 12 months. Doubtful assets: If asset remained in the substandard category for 12

months. Loss assets: Where the loss has been identified but the amount has not

been written off wholly. NPAs of Banks in India:

Total NPAs of scheduled banks in India were Rs. 81813 crs. On 31st march 2010; in which NPAs of public sector banks were Rs. 57301 crs. And NPAs of private sector banks were Rs. 17384 crs.

Among the various channels of recovery available to the banks for dealing with the bad loans, the SARFAESI and the Debt Recovery Tribunals have been the most effective.

Causes of NPAs: It should be noted that in the developed countries, NPA in the banking

sector emerge generally as the result of excess lending to the estate dealers and speculators during the boom years and subsequent collapse of property prices.

On the other hand, NPAs in the banking sector arises in the developing countries because of poor quality of the loans sanctions, nepotism (partiality) and political interference in the functioning of the banks.

Tools available with the Banks to deal with their NPAs:a) One time settlement: Banks have been advised to devise one time

settlement scheme for the resolution of NPAs, as a part of their loan recovery policy. In case of doubtful NPAs, the minimum amount for One time settlement is 100% of the outstanding balance in the account as on that date and 100% of the outstanding balance at the existing prime lending rate till the date of final payment in case of Substandard NPAs.

b) Lok Adalat: for the settlement of the cases when the outstanding balance for doubtful and loss categories is more than 5 lakh Rs. Banks approaches Lok Adalat. It helps in resolving the disputes between the parties by conciliation, mediation, compromise or available settlement and reduces the burden on courts. It is difficult to bring parties together when the Lok Adalat meets.

c) Debt Recovery Tribunals: The DRTs were set up under the Recovery of Debts due to Banks and Financial Institutions Act, 1933. There are two types of tribunals; (i) Debt Recovery Tribunals (DRTs) and (ii) Debt Recovery Appellate Tribunals (DRATs). The order of DRT is appealable at DRAT. The central government sets up the tribunals and provides them with the presiding officer, recovery officer and other employees. Under the jurisdiction of the local government, bank can file an application for the recovery to DRTs.at present there are 25 DRTs and DRATs.

d) Corporate Debt Restructuring: to provide timely and transparent system of restructuring of corporate debts of 20 crs. or above this scheme was introduced in 2001-02. Banks and financial institutions have restructured more than 100000 debts through financial restructuring, business restructuring and operational restructuring. Financial restructuring includes extension of loan maturity, reduction of interest rates, write-off principal. Business restructuring includes sale of assets or business unit, business division or merger or amalgamation. Operational restructuring includes changes in company management, special audits and liquidation of non-viable asstes.

e) SARFAESI Act: The government enacted the securitization and Reconstruction of Financial Assets and Enforcement of Security Interest (SARFAESI) Act in 2002 for realization of dues without the intervention of courts or tribunals. It aims to bring down the level of risk in system and encourage banks lending activities.

To resolve the problem NPAs effectively, the Act deals with three aspects:

i. Securitization: Conversion of financial or non-financial asset into securities.

ii. Asset reconstruction: It is a financial tool for corporate debt restructuring and financial rehabilitation through rebandling, takeovers or sale.

iii. Security enforcement: It refers to the right of lenders to foreclose a non performing loan.

The act does not apply to unsecured loans, loans below 100000 and loans where the remaining principal due is less than 20% of the amount advanced. It is an effective weapon to recover dab debts of the banks.

f) Asset Reconstruction Companies: The SARFAESI Act, 2002, surfaced the way for setting up Asset reconstruction companies to help the banks and financial institutions to clean up their balance sheets. ARC isolates non performing loans from the balance sheets of the banks and financial institutions and thereby enable them to focus on core activities. Also, it facilitates development of markets for distressed assets.

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