The note sent by dr. raghuram Rajan, former governor of the Reserve Bank of India (2013-2016) and currently professor of finance at the Booth School of Business, Chicago University, to the estimates committee of the finance ministry on September 11 is a wake-up call to the Central government and public. If root and branch reforms are not initiated pronto in the banking sector, all the grand plans made for high and sustained growth of the Indian economy are likely to go up in smoke following an imminent implosion within the country’s creaking banking system.

The Achilles heel of the banking system is that it is dominated by 27 public sector banks (PSBs) which hold 69 percent of the country’s public deposits and advance 64 percent of credit. In his note to the estimates committee Rajan has alluded that the origin of the present crisis of NPAs (non-performing assets) of the PSBs, which have risen to over 12 percent of total advances (cf. 1-2 percent of private banks), was reckless lending during the high growth years (2006-08) to politically well-connected corporates and businessmen on the basis of phone calls from politicians and ministers in Delhi, rather than according to well-established prudent banking norms. Rajan also highlights that there are no incentives to PSB managements to come clean on the subject of endangered loans.

Moreover the note warns that a large percentage of loans advanced by PSBs under the BJP-led NDA government’s politically-backed Mudra, agriculture and MSME (medium and small enterprises) loans could transform into NPAs.
The mess in India’s PSBs, which arguably have the highest NPAs globally, underscores the folly of bank nationalisation which was mandated by then Congress prime minister Indira Gandhi way back in 1969.

Nationalisation of 28 well-performing private banks was unwarranted considering that in addition to the Reserve Bank of India, the Central government already owned the State Bank of India, then as now, the country’s largest commercial bank. Although bank nationalisation, which has been perpetuated by the BJP — professedly a pro free markets and private enterprise political formation — suits the political class admirably because it has transformed the country’s largest banks into their private treasuries, it has been disastrous for the Indian economy. For over half a century annual GDP growth rate was stuck in the 3.5 percent rut because of the deficient credit assessment and risk-taking skills of bureaucrats who dominate PSBs.

Therefore the time is ripe for reversal of the 49-year-old bank nationalisation decision which has clearly done more harm than good to the Indian economy and could well do it greater harm in the future. There is no virtue in perpetuating a proven folly.