Strengthening PSU banks, the way to achieve financial inclusion 

July 18, 2017, 6:29 pm
PSU banks, the way to achieve financial inclusion 
PSU banks, the way to achieve financial inclusion 

Strengthening PSU banks, the way to achieve financial inclusion 

The public sector banks (PSBs) are the most important entities in India’s banking system, presently accounting for 70 percent of all bank deposits and 68 percent of all outstanding credit in the economy. The PSBs had acquired this strategic position in the Indian economy following the union government’s decision to nationalise fourteen large commercial banks on 19 July 1969. Despite the entry of several private banks and financial institutions into the banking sector since 1991, the PSBs have been able to maintain their dominance. These PSBs have enabled the Indian financial sector to weather the storm during the global financial crisis of 2008, since they refrained from speculative financial practises. However, the PSBs are faced with serious challenges today, with bad loans piling up on their balance sheets and the government pushing them towards disinvestment in order to raise resources for recapitalisation. Is the dilution of government’s equity in the PSBs necessary or do alternatives exist?

Advent of the PSBs

At the time of independence, banks in India were entirely in the private sector. Besides the Imperial Bank, there were five big banks, each holding public deposits aggregating Rs.100 crore (Central Bank of India Ltd., Punjab National Bank Ltd., Bank of India Ltd., Bank of Baroda Ltd. & United Commercial Bank Ltd.). The other commercial banks were also in the private sector and had a regional character. In 1947, there were 97 scheduled private banks and 557 non-scheduled small private banks. After independence, there was a phase of liquidation, consolidation and merger of smaller banks, which brought down the number of scheduled banks to 71 and non-scheduled banks to 20 by 1967. (i)

These banks were mainly run by business houses, which concentrated credit in the hands of large businesses and limited the credit access to sectors like agriculture and small-&-medium enterprises. There were also frequent instances of bank failures, which wiped out the hard earned deposits of the people. It was increasingly felt during the decade of the 1960s that the private sector dominated banking system was not playing a desirable role in the process of economic development.

While the State Bank of India was formed in 1955 by nationalising the colonial Imperial Bank of India, the first major drive to nationalise the banking industry was undertaken by the union government at the end of 1960s. On the midnight of 19 July 1969 the Government of India promulgated the Banking Companies (Acquisition and Transfer of Undertakings) Ordinance, which nationalised the fourteen largest commercial banks. The Parliament subsequently passed the bill and it became an Act on 9 August 1969. These were the Allahabad Bank, Bank of Baroda, Bank of India, Bank of Maharashtra, Canara Bank, Central Bank of India, Dena Bank, Indian Bank, Indian Overseas Bank, Punjab & Sind Bank, Punjab National Bank, Syndicate Bank, UCO Bank and United Bank of India. Six more banks were nationalised in 1980, namely the Andhra Bank, Corporation Bank, Oriental Bank of Commerce, Union Bank of India, Vijaya Bank and the New Bank of India (which was later merged with the PNB in 1993).

Bank nationalisation was among the most important economic policy decisions undertaken in post-independence India. One of the greatest economic thinkers of the twentieth century, John Maynard Keynes, once said: “Ideas, knowledge, art, hospitality, travel — these are the things which should of their nature be international. But let goods be homespun whenever it is reasonably and conveniently possible; and, above all, let finance be primarily national (emphasis added).” In keeping with that vision, the nationalisation of commercial banks was undertaken to strengthen India’s economic self-reliance. Bank nationalisation transformed banking in India by bringing about a significant expansion of banking services and ensuring financial inclusion through priority sector lending norms, which enhanced credit flow to agriculture and small industries.

PSBs and Financial Inclusion

The total number of bank branches had increased from 8262 in 1969 to 60220 in 1991, with the number of rural bank branches increasing from 1833 to 35206.(ii) This expansion was driven by the PSBs. In March 2017, the total number of bank branches and rural bank branches stood at 137770 and 48232, respectively.(iii) Chart 1 below clearly shows that the expansion of bank branches in the post-liberalization period has been lopsided, with the rate of expansion of rural branches slowing down considerably since 1991.

Reserve Bank of India
Source: Reserve Bank of India

The new private sector and foreign banks have expanded significantly in the metropolitan and urban areas, but are reluctant to open rural bank branches. Out of the 1.34 lakh bank branches in India in 2016, 68 percent were of public sector banks, 15% of regional rural banks and the rest belonging to private and foreign banks.

In 1971, two years after bank nationalisation, below 30 percent of the debt of India’s rural households were sourced from institutional sources like commercial and cooperative banks. This crossed 60 percent by 1981, with the clout of money-lenders falling considerably, owing to the expansion of banking services in rural areas and the consequent enhancement in the flow of agricultural credit. Unfortunately, this share has not changed much since 1991, with the NSS’ All India Debt and Investment Surveys of 2002 and 2012 suggesting that the share of institutional sources in the debt of rural households remained below 60 percent.(iv) The stagnation in institutional credit delivery to rural households is an important factor behind rural distress in the country, which frequently manifests itself through the tragic farmer suicides.

The present Government at the centre has relied on the opening of bank accounts under the Jan Dhan Yojana to enhance financial inclusion. Out of the 29 crore accounts opened till date under PMJDY, over 23.4 crore accounts were opened by PSBs, 4.7 crore by the regional rural banks and less than a crore by private sector banks. Around 60% of these accounts were opened in rural areas.(vi)

However, despite the Jan Dhan Yojana, rural and semi-urban bank branches account for only 27 percent of all deposits and 20 percent of total credit outstanding of the scheduled commercial banks in India, in March 2017. Moreover, growth in rural credit has slowed down considerably in the last financial year (2016-17) to 4 percent, compared to 12-14 percent annual growth of rural credit in the three preceding years. The credit-deposit ratio for rural branches has also worsened sharply in 2016-17 (vi). Thus, so far, the PMJDY has not achieved much with regard to financial inclusion in the rural areas, in terms of credit delivery. Populist schemes like the JDY cannot be a substitute for a planned expansion of banking services in the rural areas and proper enforcement of priority sector lending norms, which can revive the actual flow of rural credit. Experience suggests that this cannot be attained without the further expansion of the PSBs.

Bad Loans and Present Challenges

The public sector banks in India are currently faced with a serious challenge on account of NPAs (Non-Performing Assets) piling up over the past few years. Total bad loans (Gross Non-Performing Assets) of the commercial banks in India amounted to over Rs. 7.6 lakh crore in March 2017, out of which over Rs. 6 lakh crore belonged to the PSBs. Large borrowers, defined as those with loan exposure of over Rs. 5 crore, account for over 86 percent of the GNPAs of the scheduled commercial banks. (vii)

These amounts are mostly owed by large private corporate houses, who took these loans to finance their projects during the period of economic boom between 2003 and 2012, in sectors like power, steel and other metals, telecommunications, civil aviation, textiles, cement, construction etc. Once the boom petered, these big corporates could not pay back the loans, with many of the projects remaining incomplete. A section of the corporates has also wilfully defaulted on their loans, like Vijaya Mallya of Kingfisher.

The bad loans crisis afflicting the PSBs has hit their profitability and adversely affected credit flow, with annual credit growth for scheduled commercial banks slowing down to 5.4 percent in March 2017, which is the lowest in six decades. Chart 2 below shows the contrast between the credit growth of private banks, which has remained above 15 percent since 2010-11, and that of the PSBs which has nosedived to around 4 percent for the SBI Group and 0.6 percent for all other nationalised banks taken together. (vii) Such a sharp slowdown in PSBs’ credit growth is having an all-round adverse impact on the economy.

Reserve Bank of India
Source: Reserve Bank of India

The resolution of the NPA problem has acquired urgency in this context. The government and the RBI have gone soft on delinquent corporates for too long and provided them with much relief, through debt restructuring and write offs. Such mercy is neither shown to the farmers and small businesses when they default on their loans, nor to the middle class borrowers availing home loans or consumer loans. That the government lacks the requisite political will for recovering these NPAs, even from the wilful defaulters, could be seen in Vijay Mallya’s case, who was allowed to leave the country and avoid the Supreme Court trial.

The solution to the NPA problem lies in the PSBs taking over of the assets of delinquent corporates and auctioning them to recover the amounts they owe. Where the government needs to act is in simplifying the processes that can facilitate these takeovers and plug legal loopholes which enable delinquent corporates to entangle PSBs in lengthy legal battles. Action on these lines, under the Insolvency and Bankruptcy Code enacted in 2016 and other mechanisms, is yet to be seen.

Rather, in keeping with their neoliberal policy vision, the government and the RBI are now pushing for the divestment of government equity in the PSBs. This is being advocated in order to raise resources for recapitalization of the PSBs, to meet the Basel-III norms of capital adequacy. As per the “Indradhanush” Plan of the present government which has been operationalised from 2015, the government will allocate Rs. 70,000 crore over four years for capital infusion into the PSBs, while Rs. 1.1 lakh crore will have to be raised by the PSBs through disinvestment. Presently, government shareholding in the SBI Group is around 62 percent, Bank of Baroda 59 percent, PNB 65 percent, IDBI 74 percent, Canara Bank 66 percent, Central Bank of India 81 percent and so on. The Government plans to bring down government shareholding in the PSBs to 52 percent, through stake sale. This step, if adopted, will initiate a process of reversal of the bank nationalization of 1969.

There is, however, no need for such disinvestment by the PSBs. Even if 20 percent of Rs. 6 lakh crore GNPAs of PSBs are recovered, it would be sufficient to meet the capital infusion target set for the PSBs. That is what the government should seriously attempt.

The government should also introspect on the factors behind bad loans accumulation. A prime reason for rising NPAs in PSBs lies in the premature demise of the Development Financial Institutions (DFIs) in India like the ICICI, IDBI, UTI etc. which were converted into private commercial banks, following the recommendations of Narasimham Committee. In the absence of these DFIs, which used to specialize in long-term project financing for industry and infrastructure, the burden of financing private corporate investments have fallen on the public sector commercial banks, which are ill-prepared for handling such advances. Long-term solution to the problem of industrial financing, therefore, requires a revival of the DFIs and allowing the PSBs to focus on their core area of commercial banking.


Instead of diluting its stakes in the banks, the government needs to focus on strengthening the PSBs in order to develop India’s financial system and ensure financial inclusion. We should not forget that it was nationalisation of the commercial banks that paved the way for the expansion of the banking sector and helped in building a resilient financial sector. Further expansion, technological modernisation and improvement in service quality as well as financial performance of the PSBs should be brought about, while maintaining its public sector character and safeguarding its social role.


(i) - All historical data sourced from the Special Edition of the Report on Currency and Finance, 2006-08, Vol. IV, RBI

(ii) - Data sourced from Rakesh Mohan and Partha Ray, “Indian Financial Sector: Structure, Trends and Turns”, IMF Working Paper, January 2017

(iii) - Data sourced from RBI’s online Database of Indian Economy

(iv) - Table 4 in Rakesh Mohan and Partha Ray, IMF Working Paper (2017)

(v) - PMJDY data sourced from (Accessed on 17.07.2017)

(vi) - Author’s calculations based on data sourced from Database of Indian Economy

(vii) - Data sourced from Financial Stability Report, RBI, June 2017

(viii) - Author’s calculations based on data sourced from Database of Indian Economy