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Banking Reform in India

A b h i j i t V . B a n e r j e e , S h a w n C o l e , a n d E s t h e r D u fl o

June2004

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Introduction

Measured by share of deposits, 83 percent of the banking business in India is in the hands of state or nationalized banks, which are banks that are owned by the government, in some, in- creasingly less clear-cut way. Moreover, even the non-nationalized banks are subject to extensive regulations on who they can lend to, in addition to the more standard prudential regulations.

Government control over banks has always had its fans, ranging from Lenin to Gerschenkron. While there are those who have emphasized the political importance of public control over banking, most arguments for nationalizing banks are based on the premise that profit maximizing lenders do not necessarily deliver credit where the social returns are the highest. The Indian government, when nationalizing all the larger Indian banks in 1969, argued that banking was “inspired by a larger social purpose” and must “subserve national priorities and objectives such as rapid growth in agriculture, small industry and exports.1

There is now a body of direct and indirect evidence showing that credit markets in developing countries often fail to deliver credit where its social product might be the highest, and both

We thank the Reserve Bank of India, in particular Y.V. Reddy, R.B. Barman, and Abhiman Das, for generous asssitance with technical and substantative issues. We also thank Abhiman Das for performing calculations which involved proprietary RBI data, as well as Saibal Ghosh and Petia Topalova for helpful comments. We are grateful to the staff of the public sector bank we study for allowing us access to their data. We gratefully acknowledge financial support from the Alfred P. Sloan Foundation.

  • Department of Economics, MIT

  • Department of Economics, MIT, NBER, and CEPR

1 From the “Bank Company Acquisition Act of 1969.” Quoted by Burgess and Pande (2003).

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