Public Sector Banks and Financial Reach

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India runs one of the largest state owned banking systems in the world, and it does so deliberately. Public sector banks hold a very large share of deposits and lending and are expected to do things a purely commercial bank would not: open branches in places that will never be profitable, lend to farmers at administered rates, and carry the plumbing for government welfare payments. Whether that combination of commercial and social roles is a strength or a permanent handicap is the central argument in Indian banking policy, and it has been running for more than fifty years.

Nationalisation and the branch mandate

The state's involvement began before independence in substance and was formalised soon after. The Imperial Bank of India, itself created in 1921 from three presidency banks, was converted into the State Bank of India by an Act of Parliament in 1955, with the Reserve Bank as its majority shareholder, expressly so that a large bank could be directed into rural areas. The decisive break came on 19 July 1969, when the government of Indira Gandhi nationalised fourteen private banks whose deposits exceeded a specified threshold. A second round in April 1980 brought six more into public ownership. The stated purpose was to redirect credit away from a small circle of industrial houses and towards agriculture, small industry and what the policy documents of the period called the neglected sectors.

The machinery built around nationalisation matters more than the ownership change itself. The Lead Bank Scheme, introduced in 1969, assigned each district to a particular bank charged with surveying credit needs and coordinating branch expansion. Branch licensing rules obliged banks to open offices in unbanked locations in return for permission to open profitable urban ones. Priority sector lending norms required a defined share of bank credit, set at forty per cent of adjusted net bank credit for domestic commercial banks, to flow to agriculture, micro and small enterprises, education, housing and weaker sections, with sub targets inside that. Regional Rural Banks were created from 1975, jointly owned by the central government, a state government and a sponsoring commercial bank, to serve rural districts with lower cost structures. NABARD was established in 1982 as the apex refinancing institution for rural credit, and from 1992 it promoted the linkage of self help groups, mostly of women, to bank branches.

The result was a very large expansion of physical banking: India went from a few thousand branches at the time of the first nationalisation to tens of thousands within two decades, with the bulk of new offices in rural and semi urban locations. The cost is equally well documented. Directed lending at administered rates, weak credit appraisal and periodic loan waivers announced for political reasons produced portfolios of doubtful quality that the banks were not free to refuse.

From branches to accounts to phones

By the 2000s the constraint had shifted. A branch every few dozen villages is expensive and still leaves many households outside the system. The Reserve Bank's business correspondent framework, introduced in 2006, made the last mile cheaper by allowing banks to appoint agents, including shopkeepers, self help groups and later corporate networks, to open accounts and handle small cash transactions on their behalf using handheld devices.

The Pradhan Mantri Jan Dhan Yojana, launched on 28 August 2014, then pushed account opening at a scale no country had attempted: zero balance accounts with a debit card and accident cover, opened in enrolment camps, running into several hundred million accounts. Linked to Aadhaar identification and to mobile numbers, this became the rail for Direct Benefit Transfer, under which subsidies for cooking gas, wages under the rural employment guarantee, scholarships and pensions are credited to accounts rather than distributed in cash or in kind. Supporters point to reduced leakage and to the speed of relief payments during the pandemic. Critics point to dormant accounts, to households far from any cash out point, and to exclusion caused by biometric authentication failures among manual labourers and the elderly. Both observations are well evidenced.

Payments technology has since moved faster than the banks themselves. The National Payments Corporation of India, a not for profit company set up by the Reserve Bank and the Indian Banks Association, launched the Unified Payments Interface in 2016. UPI allows instant transfers between bank accounts through third party applications, and it now carries a volume of retail transactions that dwarfs card payments. The public banks provide the accounts and the settlement while much of the customer relationship has migrated to technology companies, a structural change whose consequences for bank revenue are still working themselves out.

Bad loans, mergers and the argument about ownership

The system's worst period followed the infrastructure and steel lending boom of the late 2000s. When those projects stalled, banks rolled over loans rather than recognise losses. The Reserve Bank's asset quality review, ordered in 2015 under Governor Raghuram Rajan, forced recognition and revealed a stock of non performing assets far larger than reported, concentrated in public sector banks. The response combined the Insolvency and Bankruptcy Code of 2016, which created a time bound resolution process with creditors in control, and large recapitalisation using specially issued bonds from 2017.

Consolidation followed. State Bank of India absorbed its five associate banks and the Bharatiya Mahila Bank in April 2017, and Bank of Baroda absorbed Vijaya Bank and Dena Bank in 2019. A further round of mergers announced in 2019 took effect on 1 April 2020, reducing the number of public sector banks from twenty seven a few years earlier to twelve. The reasoning was that fewer, larger banks would have stronger balance sheets and better technology; the counter argument is that mergers absorb management attention for years and that scale was never the binding constraint on credit appraisal.

That leads to the unresolved question. One camp argues that public ownership is precisely what delivered rural branches, priority sector credit and the ability to execute a national account opening drive in months, and that private banks would simply not have done it. The other argues that dual control by the Reserve Bank and the Finance Ministry, politically influenced lending and civil service pay scales make these banks structurally weak, and that the state should retain a small number and sell the rest. The government has moved cautiously, announcing an intention to privatise a small number of banks and pursuing the sale of its stake in IDBI Bank, while retaining the core of the system. The argument is unlikely to be settled by evidence alone, because the two sides weigh different things: reach on one hand, the fiscal cost of periodic recapitalisation on the other.

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