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Banking Reform in India∗ - page 13 / 57





13 / 57


Bank Ownership and Sectoral Allocation of Credit

As mentioned above, an important rationale for the Indian bank nationalizations was to direct credit towards sectors the government thought were underserved, including small scale industry, as well as agriculture and backward areas. Ownership was not the only means of directing credit: the Reserve Bank of India issued guidelines in 1974, indicating that both public and private sector banks must provide at least one-third of their aggregate advances to the priority sector by March 1979. In 1980, it was announced that this quota would be increased to 40 percent by March 1985. Sub-targets were also specified for lending to agriculture and weaker sectors within the priority sector. Since public and private banks faced the same regulation, in this section we focus on how ownership affected credit allocation.

The comparison of nationalized and private banks is never easy: banks that fail are often merged with healthy nationalized banks, which makes the comparison of nationalized banks and non-nationalized banks close to meaningless. The Indian nationalization experience of 1980 represents a unique chance to learn about the relationship between bank ownership and bank lending behavior. The 1980 nationalization took place according to a strict policy rule: all private banks whose deposits were above a certain cutoff were nationalized.18 After 1980, the nationalized banks remained corporate entities, retaining most of their staff, though the board of directors was replaced by nominees of the Government of India. Both the banks that got nationalized under this rule and the banks that missed being nationalized, continued to operate in the same environment, and face the same regulations and therefore ought to be directly comparable.

Even this comparison between banks just nationalized and just not nationalized may be in- valid, because policy rule means that banks nationalized in 1980 are larger than the banks that remained private. If size influences bank behavior, it would be incorrect to attribute all differ- ences between nationalized and private sector banks to nationalization. In this section, based on Cole, we adopt an approach in the spirit of regression discontinuity design, and compare banks that were just above the 1980 cutoff to those that were just below the 1980 cutoff, while control-

18 While the 1969 was larger, and also induced a discontinuity, we do not use it because many of the banks just below the cut-off in 1969 were nationalized in 1980.


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