In 1969, India nationalised 14 banks to help cement state control over the financial system. Five decades later, it has taken the first steps towards undoing crucial parts of that legacy by unveiling plans to privatise two of twelve state-owned lenders. MOIN QAZI has spent most of his professional banking career in villages. He argues that public banks have historically played a stellar role in financial inclusion and the development of the social sector. He recounts some useful lessons that can keep alive the original spirit behind the nationalisation of banks.
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SOON, we will see a spate of privatisations. The more profound effects of this new policy approach will be felt by the banking sector. Here it is largely an issue of ideology. The nationalisation of banks was done to serve a social purpose that the private banks will never fulfill. Hence the decision of the government to privatise public sector banks may slow down the growth of priority sectors of the economy.
I know firsthand of the role public sector banks play in bringing about life-transforming changes in the lives and livelihoods of villagers, particularly women. The need for privatisation arose because of the weakening financial strength of some of these banks. We must remember that most of the problems public banks find themselves in are largely a result of the flawed policies of the government. We need to address the malady that lies at the root of the crisis, not just the symptoms.
However, there certainly needs to be some balance between what is important for a development agenda versus privatisation. Some privatisation will result in a much more organised playing field with both stronger state and private lenders.
Saga of rural banking
Rural banking has come a long way from the days when bankers had their first brush with rural culture. Bankers are now financial anthropologists, and many of them are playing a missionary role in transforming rural societies. However, challenges persist. When rural banking took its baby steps, villagers were shy of taking out loans because they always related them with moneylenders and carried bitter memories of those who had suffered at their hands.
The situation today is quite the opposite. People have a savage appetite for loans, but unlike their forebears, they have lost that pristine morality that equated loan default with shame or guilt. Banks are piling up mountains of sour loans and governments are brushing them off with buckets of precious public money.
While the positive social and economic impacts of nationalisation were quite evident, the experiment was also an eye-opening lesson in the disaster that mindless bureaucratic programmes can become. Rural banking in India has suffered severely on account of populist measures of the state. What populist leaders wanted was that the cash spigots be turned on permanently. The most fundamental canons and nostrums of banking were thrown to the wind by vote-hungry politicians. Banks were saddled with mountains of sour loans whose stink leached the entire rural credit system.
The assumptions and suppositions on which the nationalisation of banks was premised did not hold much water. Delivering development is essentially a government’s job. Bankers were just expected to be financial midwives but were finally entrusted with the task of birthing development. Instead of writing off loans, the government should funnel that money into infrastructure development and allow banks to do their job professionally.
The new paradigm must recognise the boundaries that separate banking and the government.
The original concept of banking, based on security-oriented lending, was broadened after the nationalisation of banks to a social banking concept based on purpose-oriented credit for development. This called for a shift from urban to rural-oriented lending.
The suppositions on which the nationalisation of banks was premised did not hold much water. Delivering development is essentially a government’s job. Instead of writing off loans, the government should funnel money into infrastructure development.
Social banking was conceptualised as “better the village, better the nation.” However, opening branches in rural areas without proper planning and supervision of the end-use of credit, or creating basic facilities meant that branches remained mere flagposts. It was a make-believe revolution that was to lead to a serious financial crisis in the years to come.
Flawed development paradigm
The Integrated Rural Development Programme (IRDP) is a grim reminder of how trying to meet targets mechanically can undermine the integrity of a social revolution, to such an extent that a counter-revolution can be set into motion. Arguably India’s worst-ever development scheme, IRDP was intended to provide income-generating assets to the rural poor through providing cheap bank credit. Little support was given to skill formation, access to inputs, and markets, nor necessary infrastructure.
The original concept of banking, based on security-oriented lending, was broadened after the nationalisation of banks to a social banking concept based on purpose-oriented credit for development. This called for a shift from urban to rural-oriented lending.
With cattle loans, for example, a majority of cattle owners reported that either they had sold off the animals bought with the loan or that those animals were dead. Cattle loans were financed without adequate attention to other details involved in cattle care: whether fodder was available, or veterinary services were accessible, or marketing linkages for milk, among others.
Working for the poor does not mean indiscriminately thrusting money down their throats. Unfortunately, IRDP did precisely that. The programme did not attempt to ascertain whether the loan provided would lead to the creation of a viable long-term asset. Nor did it attempt to create the necessary forward and backward linkages to supply raw material or establish marketing linkages for the produce. Little information was collected on the intended beneficiary.
IRDP was principally an instrument for powerful local bosses to opportunistically distribute political largesse. The abiding legacy of the programme for India’s poor has been that millions have become bank defaulters from no fault of their own.
People erroneously came to believe that the state had all the answers to their problems. Governments, international financial institutions, and non-governmental organisations (NGOs) threw vast amounts of money at credit-based solutions to rural poverty, particularly in the wake of the World Bank’s 1990 initiative to put poverty reduction at the head of its development priorities. Yet, those responsible for such transfers had—and in many cases, have—only the haziest grasp of the unique demands and difficulties of rural life.
Subsidy culture
An even more serious problem is the possible chilling effect of subsidies on the commercial provision of competing and offering potentially better services to the poor. Subsidising finance has severely undermined the motivation and incentive for market-driven financial firms to innovate and deliver.
As in other areas of development, the use of public funds is easy to justify in the interest of improving access and thereby promoting pro-poor growth. Such subsidies, of course, need to be evaluated against the many alternative uses of the donor or scarce public funds involved, not least of which are alternative subsidies to meet education, health, and other priority needs for the poor themselves.
In practice, such a cost-benefit calculation is rarely made. Indeed, the scale of subsidy is often unmeasured.
All these instances highlight how an unenlightened politician can play havoc with the financial systems. The execution of most development programmes lacked the soul of a genuine economic revolution because it was not conceived by grassroots agents but assembled by starry-eyed mandarins, who had picked up bits and pieces about financial inclusion from pompous newfangled and half-baked ideas generated at seminars and conferences.
Cheap loans, followed by periodical waivers and write-offs, have been the hobby horse of armchair experts and lazy policymakers.
A poverty-eradication programme must mop up the surplus with the elite classes. Besides, the government must aim at a strategy for the development of the social sector—the key component should be population control, universal primary education, family welfare, and job creation, especially in rural areas. These and other aspects of poverty alleviation have not received much importance in our planning.
Indiscriminate expansion
During the massive banking expansion phase in the 1980s, opening a bank branch was made to look as casual as punching a flag post. It was impossible to locate a proper structure to house the bank. The existence of a toilet or a medical centre, a police post, or a primary school in a village, as a precondition for a bank branch, was simply overlooked.
Most development programmes are a grim reminder of how mechanically trying to meet targets can completely undermine the integrity of a veritable economic and social revolution to such an extent that a counter-revolution can be set into motion.
In several cases when the expiry of the Reserve Bank of India (RBI) licence for the opening of the bank branch approached without proper premises being identified, banks were housed in a temple or a local community centre, marked by a small banner and a photograph shown as evidence of the launch of the bank’s operations.
Rural branch expansion during that period may have accounted for substantial poverty reduction, largely through an increase in non-agricultural activities, which experienced higher returns than agriculture, and especially through an increase in unregistered or informal manufacturing activities. But there was a significant downside; commercial banks incurred large losses on account of subsidised interest rates and high loan losses -indicating potential long term damage to the credit culture.
The privatisation agenda should not mean that the progress achieved through nationalisation of banks is rolled back. Public banks have played a historically stellar role in financial inclusion and the development of the social sector. They have been the backbone of the government’s socio-economic agenda and have made a transformative impact on the country’s development landscape.
In any rural area, the role of a public bank is not confined to banking but encompasses a more holistic developmental agenda. We need to pursue more aggressively a rural-centric bank model. The present urban-centric model has shown that it is a recipe for disaster when used in villages. Rural areas have special characteristics and local needs.
The privatisation agenda should not mean that the progress achieved through nationalisation of banks is rolled back. Public banks have played a stellar role in financial inclusion and the development of the social sector.
We need to hire local people to understand local needs. The whole model has to be driven by high-grade technology and a few simple products that can be tailored to local needs. Let us hope that the wisdom gleaned from our learning is harnessed towards the right destination.
(Dr. Moin Qazi is a well-known development professional. The views expressed are personal.)
