TERM PAPER

OF
MONEY and FINANCIAL MARKETS

TOPIC :Private sector banks V/s Public sector Banks. The arguments regarding
the policy of nationalization and privatization of banks .
INTRODUCTION
The private sector banks in India are banks where the majority of the shares or equity are held by
private share holders .In 1969 all major banks were nationalized by the Indian government. Some
of the private banks of India are Axis Bank , HDFC bank , Yes Bank etc.

Public Sector Banks (PSBs) are a major type of bank in India, where a majority stake is held by
a government.The Central Government entered the banking business with the nationalization of
the Imperial Bank of India in 1955. Some of the public banks of India are Bank of Baroda , Bank
of India , UCO Bank ,etc.

When talking about banks we come across two mostly used terms regarding banking system i.e.
nationalization and privatization of the banks in India. Nationalization, is the process of
transforming private assets into public assets by bringing them under the public ownership of a
national government or state.[1] Nationalization usually refers to private assets or assets owned
by lower levels of government, such as municipalities, being transferred to the state.

Privatization is transfer of ownership from the public to the private sector as well as the control
over assets. In broader terms, it involves greater influence on demand and supply force, make
sure that there is higher competition, it brings greater involvement in government activities. It
brings liberalization in different regulations to release forces of competition and to implement
demand and supply forces into the economy.
LITERATURE Review
Nationalization of Banks
Reasons for nationalization

i) The Revenue Issue: Nationalization of banks would enable the Government to obtain all the
large profits of the banks as its revenue.

(ii) The Safety Issue: Nationalization of banks would safeguard and promote the interests of
depositors. As a result public would deposit very rapidly a large
amount of money.

(iii) The Monopoly Issue: All major private banks in India were controlled by one big business
house or the other or jointly by a few of them. Nationalization of banks was desirable to prevent
the spread of the monopoly enterprise.

(iv) The Use Issue: The benefit of commercial banks' massive financial resources had gone
largely to the big business which controlled these. The manipulation of bank advances helped in
increasing some anti-social and illegal activities such as hoarding, black-marketing etc.
Nationalization of banks would help in stabilizing the price levels by eliminating artificial
scarcity of essential goods and encouraging development of bank resources for productive
purposes.

(v)Rural Issue: Private sector banks were not interested in opening their branches in semi-urban
and rural areas. After nationalization, disparity in the spread of banking facilities would be
removed and rural banking would receive a big push through public sector banking.

(vi) The Credit Issue: Private commercial banks adopted traditional approach in their credit
policy which was not conducive to a rapid, balanced development of all the sectors of our
economy. Nationalization of banks was considered as important matter to allocate bank finance
for the needs of Indian economic development.

(vii) The Service Motive Issue: By nationalization commercial banks would change their
function from profit motive to service motive in order to achieving the goal of socialism.
Achievement after nationalization
By and large, nationalized banks have achieved some phenomenal success in regard to attaining
the objectives of nationalization. A dramatic change has occurred in the profile of Indian banking
especially in the deployment of commercial bank credit which has made banks as effective
catalytic agents of socioeconomic change in the country.The following are the major achievements
of public sector commercial banks:

Branch Expansion: There has been a rapid progress in branch expansion of public sector
banks especially in the rural and semi-urban areas, which was one of the primary objectives of
nationalization. From [Source: RBI Bulletin, Report on Trend & Progress of Banking in India, 1989-90, 1994-95 and 2004-05
respectively] shows that branch expansion of Indian scheduled commercial banks increased by
53,372 in number and the overall rate of branch expansion of was 641 % during this period, in
which nationalized banks increased their braches by 629 %.Branches of SBI and its associate
banks increased by 412 % and those of Indian private sector banks by 136 % during this period.

Deposit Mobilization and Credit Expansion: There has been a spectacular rise in the rate
of deposit mobilization and in the bank credit during the post-nationalization period. [Source: RBI
Bulletin, Report on Trend & Progress of Banking in India, 1970-71, 1989- 90 and 1994-95 respectively] This shows that aggregate
deposits increased from Rs.4640 crore in 1969 to Rs. 140150 crore in 1989 and thereafter also
increased in 1994 by Rs. 174982 crore. Total bank credit of all Indian scheduled commercial
banks recorded a jump from Rs. 3599 crore to Rs. 84719 crore during the period June 1969 to
March 1989 and thereafter, it became approximately doubled from Rs. 84 719 crore in March
1989 to Rs. 164418 crore in March 1994.

Advances to Priority sectors: Since, one of the important objectives of bank nationalization
was to channelise the flow of credit to the priority sectors, after nationalization, there was a
remarkable change in the credit policy of the banks. Credit to the priority sectors especially
agriculture, small-scale industry and small transport operators were given more importance by
the policy makers. In addition, other priority sectors such as retail trade, professional and self-
employed persons, education, housing loans for weaker sections. the share of the priority sectors
in net bank credit of the public sector banks increased from nearly 15 % in June 1969 to 37.8 %
in March 1994. Between June 1969 and March 1994, the number of borrowal accounts with the
public sector banks under priority sectors rose from 2.60 lakh to 365.0 lakh which was about 140
times. . [Source: RBI Bulletin, Report on Trend & Progress of Banking in India, 1970-71, 1989- 90 and 1994-95 respectively]

Social Banking: Special Employment and Poverty alleviation programmes: As social

banking, the public sector banks have played a significant role in financing their funds in various
social sector schemes sponsored by the Government of India for employment generation and
poverty alleviation. Some of those schemes are: Differential Rate of Interest (DRI), Employment
Scheme for Educated Unemployed Youth (SEEUY), Self-Employment Programme for Urban
Poor (SEPUP), Integrated Rural Development Programme (IRDP).

Criticisms against nationalization of banks

1. It was erroneous to assume that after nationalization the Government would secure large
revenues by way of profits from banks. But according to the statistical data of the Reserve Bank
of India, a small portion of total profit earned by the nationalized commercial banks went to
Government after nationalization. Nationalization also led to the payment of heavy compensation
to the shareholders of the private sector banks. This gave additional financial burden on the
Government.

2. It was said that before nationalization private sector banks were involved in malpractices and
did not safeguard the interests of their depositors. But thisargument was wrong when the banks
were performing their functions strictly under the control of Reserve Bank and Banking
Regulation Act. Further, Deposit Insurance Corporation was established to protect the interests
of the depositors. In this situation, the argument that nationalized banks would get greater
confidence from the public and secure larger deposits from it had no validity. State monopoly in
banks would result in irresponsibility, inefficiency, rigidity, bureaucracy, corruption and
deteriorated services to the customer. So, the confidence of the public would be lost from the
nationalized banks.

3. It was also incorrect to say that private sector banks were responsible to create monopolies
and concentration of economic power in a few hands. In fact, it was the operation of Government
policies of industrial, import and other licensing and of plan priorities that had encouraged some
big concerns to come into existence and flourish. . Banks financed their resources to these
concerns only because they had been playing a vital and commanding role in the economic setup,
planned and assigned by the Government. If these firms did not get bank credit, they could not
run their business which caused wastage of community's resources.

4. It was expected that after nationalization public sector banks would receive better
co-operation from their employees. There was no cordial relationship between management and
employees.
PRIVATIZATION of BANKS
Benefits of privatization
1. Improved efficiency
The main argument for privatisation is that private companies have a profit incentive to cut costs
and be more efficient. If you work for a government run industry managers do not usually share
in any profits. However, a private firm is interested in making a profit, and so it is more likely to
cut costs and be efficient. Since privatisation, companies such as BT, and British Airways have
shown degrees of improved efficiency and higher profitability.

2. Lack of political interference

It is argued governments make poor economic managers. They are motivated by political
pressures rather than sound economic and business sense. For example, a state enterprise may
employ surplus workers which is inefficient. The government may be reluctant to get rid of the
workers because of the negative publicity involved in job losses. Therefore, state-owned
enterprises often employ too many workers increasing inefficiency.

3. Short term view

A government many think only in terms of the next election. Therefore, they may be unwilling to
invest in infrastructure improvements which will benefit the firm in the long term because they
are more concerned about projects that give a benefit before the election. It is easier to cut public
sector investment than frontline services like healthcare.

4. Shareholders
It is argued that a private firm has pressure from shareholders to perform efficiently. If the firm is
inefficient then the firm could be subject to a takeover. A state-owned firm doesn’t have this
pressure and so it is easier for them to be inefficient.

5. Increased competition
Often privatisation of state-owned monopolies occurs alongside deregulation – i.e. policies to
allow more firms to enter the industry and increase the competitiveness of the market. It is this
increase in competition that can be the greatest spur to improvements in efficiency. For example,
there is now more competition in telecoms and distribution of gas and electricity.

 However, privatisation doesn’t necessarily increase competition; it depends on the nature

of the market. E.g. there is no competition in tap water because it is natural monopoly.
There is also very little competition within the rail industry.
6. Government will raise revenue from the sale
Selling state-owned assets to the private sector raised significant sums for the UK government in
the 1980s. However, this is a one-off benefit. It also means we lose out on future dividends from
the profits of public companies.

Critism against privatization of the banks

1) Private sector focuses more on profit maximization and less on social objectives unlike
public sector that initiates socially viable adjustments in case of emergencies and
criticalities.

2) There is lack of transparency in private sector and stakeholders do not get the complete
information about the functionality of the enterprise.

3) Privatization has provided the unnecessary support to the corruption and illegitimate
ways of accomplishments of licenses and business deals amongst the government and
private bidders. Lobbying and bribery are the common issues tarnishing the practical
applicability of privatization.

4) Privatization loses the mission with which the enterprise was established and profit
maximization agenda encourages malpractices like production of lower quality products,
elevating the hidden indirect costs, price escalation etc.

5) Privatization results in high employee turnover and a lot of investment is required to train
the lesser-qualified staff and even making the existing manpower of PSU abreast with the
latest business practices.

6) There can be a conflict of interest amongst stakeholders and the management of the
buyer private company and initial resistance to change can hamper the performance of
the enterprise.

7) Privatization escalates price inflation in general as privatized enterprises do not enjoy

government subsidies after the deal and the burden of this inflation affects the common
man.