Why Indira Gandhi Nationalised India’s Banks
The economic and political climate through the 1960s moved inevitably towards bank nationalisation, writes Amol Agrawal.
The year 2019 marks 50 years of India’s Bank Nationalisation. On July 19, 1969, Indira Gandhi who was both Prime Minister and Finance Minister at that time decided to nationalise 14 largest private banks of the country.
With Imperial Bank already nationalised and renamed as State Bank of India in 1955, this decision pushed 80 percent of banking assets under the control of the state. The third volume of Reserve Bank of India’s history termed nationalisation of banks as the “single most important economic decision taken by any government since 1947. Not even the reforms of 1991 are comparable in their consequences—political, social and, of course, economic.”
Political And Economic Background
The reason for nationalising banks was to sync the banking sector with the goals of socialism adopted by the Indian government after independence. RBI’s history points that the idea to nationalise banks and insurance companies germinated as early as 1948, in an All India Congress Committee report. The insurance sector was nationalised in 1956 with the formation of Life Insurance Corporation of India but banks had to wait till 1969, barring the case of SBI which was nationalised in 1955.
India’s political drama in the 1960s, before bank nationalisation, deserves special mention. As RBI’s history points out, we had war with China in 1962, followed by Prime Minister Jawaharlal Nehru’s death in 1964. This led to the appointment of Lal Bahadur Shastri as Prime Minister who soon saw war with Pakistan in 1965. Then Shastri died suddenly in 1966, leading to the appointment of Indira Gandhi as Prime Minister. The ruling Indian National Congress was in turmoil, which showed in subsequent election results. In the Lok Sabha elections of 1967, the Congress won 283 seats of the total 520, sharply lower than the 361 of 494 it won in 1962. Further, the party lost power in seven states.
Apart from these political events and wars, the 1960s also had two droughts, leading to negative GDP growth rates and double-digit inflation. Foreign exchange too declined in 1964-65.
These economic conditions led the government to devalue the Rupee from 4.76 per U.S. dollar to Rs 7.50/$ in 1966. Apart from devaluation, export duties were levied on a dozen commodities.
The decision was criticised across corners as the centre had denied the possibility of devaluation before making the move. No less than the Congress president at the time, K Kamraj, dubbed it as “sell-out to Americans”.
Prime Minister Indira Gandhi needed a serious instrument to reposition herself as a radical reformer and she used nationalisation of banks to signal this change.
The 1960s also saw three RBI governors. HVR Iengar was governor from March 1957 to February 1962, followed by PC Bhattacharyya from March 1962 to June 1967, who oversaw the devaluation and droughts. LK Jha, who was the governor from July 1967 to May 1970, had to manage the bank nationalisation process.
Class Banking Also A Reason
Apart from political and economic factors, there were banking reasons as well. There was a long-standing criticism that Indian banks were not willing to provide credit to agriculture. Also, since the private banks were run by big industrialists, they gave loans to themselves. The directors of the top banks also held directorships in several other industries leading to conflict of interest.
The share of agriculture in credit was 2 percent in 1951 and remained unchanged in 1967. Whereas, the share of industry increased from 34 percent in 1951 to 64.3 percent in 1967.
We see a similar picture in bank branches as well. Banks had increased branches from around 4,000 in the 1950s to around 7,000 by 1967 but the share of rural and semi-urban branches remained similar at 61 percent. The share of urban branches increased from 36 percent in 1952 to 39 percent in 1967.
Social Control Before Nationalisation
Morarji Desai, Deputy Prime Minister and Finance Minister in the Indira Gandhi government, tried to find a middle-of-the-road solution and came up with the idea of ‘social control of banks. Under the Banking Laws Amendment Act (1968), the government asked banks to change the profile of directors and prohibited loans to directors and their firms. A ‘National Credit Council’ was established whose task was to align the banking system towards national goals of planning and development. One of NCC’s major goals was to direct bank lending to priority sectors such as agriculture and small-scale industry. NCC proposed doubling credit towards both these sectors.
Meanwhile, the banks had a whiff that they would eventually be nationalised.
While presenting their annual reports, some of them suggested that nationalisation was not needed as they had oriented towards these ‘social goals’.
In 1967, Homi Mody, chairperson of Central Bank of India, said that “there was not a single cogent or valid economic argument” favoring nationalisation or social control of banks. Later, in May 1969, VC Patel, chairperson of the same bank, realising social control has been implemented, pointed out how the bank was making progress towards rural credit and branches.
TA Pai, chairperson of Syndicate Bank, who also chaired the NCC, remarked in 1967 that “nationalisation of banks is not necessary as the banking industry has not failed to fulfil its objectives and that the government, through the Reserve Bank, has very vast and effective control over commercial banks.” In his later annual statement in 1968, Pai informed the shareholders how the bank was practicing social control plans.
RBI Governor LK Jha was open to social control but did not favor nationalisation.
However, none of these proposals and statements mattered as nationalisation became inevitable by July 1969. Prime Minister Indira Gandhi raised the issue of nationalisation on July 12, 1969, leading to the resignation of Finance Minister Desai on July 16, 1969. Indira Gandhi also took over the finance portfolio. It was not a question of whether but when will the banks be nationalised. It did not take long, as the eventual date was just a week away.
The People Behind Nationalisation
IG Patel’s autobiography, ‘Glimpses of Indian Economic History’, provides a thrilling account of how the agenda was carried forward. He was the chief economic adviser and on July 18, he was asked to make the legislation in a mere 24 hours, which he duly did along with RBI Governor LK Jha and the Finance Ministry’s RK Seshadri, who were flown in urgently from Bombay. IG Patel managed to convince the Prime Minister for nationalising only the major banks and leave foreign banks out.
DN Ghosh, Deputy Secretary, Banking Division in Finance Ministry, also gives a fascinating account of the events in his book ‘No Regrets’. He, along with PN Haskar (Principal Secretary to the Prime Minister), and A Baksi (Chairperson, IFCI), spent the eventful night on July 17 preparing the legislation. It was crucial to come up with the Banking Legislation by July 19 as VV Giri, who was Acting President of India at that time, was to demit office the next day, July 20, 1969, and the Lok Sabha was to resume its session on July 21. Talk about planning!
The trio figured that top 14 banks and ANZ Grindlays, which was a foreign bank, comprised 85 percent of deposits. There were also suggestions to nationalise Andhra Bank which had deposits of Rs 42 crore. Ghosh wrote that he suggested a standardised criteria be adopted for the process.
Rs 50 crore in deposits was set as the threshold level for nationalisation. They also decided to leave out ANZ Grindlays and foreign banks from the list.
Haksar informed the Prime Minister about the 14 banks and leaving out the foreign banks and she agreed. Ghosh said, “A million words could not have held the import of Haksar’s words to the Prime Minister. Ghosh also mentions how, over a telephone call, IG Patel and he agreed to finalise the legislation at RBI’s guest house in Delhi where all the key persons could work in confidentiality.
The Banking Companies (Acquisition and Transfer of Undertakings) Act, 1969 laid down the conditions for nationalisation. The objective of the Act was “to serve better the needs of development of the economy in conformity with national policy and objectives”.
In her speech on the radio, Indira Gandhi reiterated the following words:
IG Patel mentioned how he added the words “commanding heights” to link it with past and also signal no more nationalisations would follow.
However, the 1969 legislation ran into problems. There were objections over powers of the government over the nationalised banks and discriminatory compensation levels.
This led the Supreme Court to strike down the Act on Feb 10, 1970, while upholding the legislative competence of Parliament.
A new ordinance was drafted which applied from July 19, 1969, and was passed in Parliament on February 14, 1970.
The objective of the Act was also modified: to control the heights of the economy and to meet progressively, and serve better, the needs of development of the economy in conformity with national policy and objectives and for matters connected therewith or incidental thereto.”
This article discussed the broad backdrop which led to bank nationalisation. The next article will focus on the 14 banks that were nationalised.
Amol Agrawal is a faculty member at Ahmedabad University. He has a PhD in Indian Banking History and writes the Mostly Economics blog.
The views expressed here are those of the author and do not necessarily represent the views of BloombergQuint or its editorial team.