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Banking Reform in India∗ - page 39 / 57





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later, better regulation of public banks may also achieve similar goals.

Historically, a crucial difference between public and private sector banks has been their willingness to lend to the priority sector. The recent broadening of the definition of priority sector has mechanically increased the share of credit from both public and private sector banks that qualify as priority sector. The share of priority sector lending from public sector banks was 42.5 percent in 2003, up from 36.6 percent in 1995. Private sector lending has shown a similar increase from its 1995 level of 30 percent. In 2003 it may have surpassed for the first time ever public sector banks, with a share of net bank credit to the priority sector at 44.4 percent to the priority sector.49

Still, there are substantial differences between the public and private sector banks. Most notable is the consistent failure of private sector banks to meet the agricultural lending sub- target, though they also lend substantially less in rural areas. Our evidence suggests that privatization will make it harder for the government to get the private banks to comply with what it wants them to do. However it is not clear that this reflects the greater sensitivity of the public banks to this particular social goal. It could also be that credit to agriculture, being particularly politically salient, is the one place where the nationalized banks are subject to political pressures to make imprudent loans.

Finally, one potential disadvantage of privatization comes from the risk of bank failure. In the past there have been cases where the owner of the private bank stripped its assets, and declared that it cannot honor its deposit liabilities. The government is, understandably, reluctant to let banks fail, since one of the achievements of the last forty years has been to persuade people that their money is safe in the banks. Therefore, it has tended to take over the failed bank, with the resultant pressure on the fiscal deficit. Of course, this is in part a result of poor regulation–the regulator should be able to spot a private bank that is stripping its assets. Better enforced prudential regulations would considerably strengthen the case for privatization.

On the other hand, public banks have also been failing–the problem seems to be part corruption and part inertia/laziness on the part of the lenders. As we saw above, the cost of bailing out the public banks may well be larger (appropriately scaled) than the total losses

incurred from every bank failure since 1969. 49 All numbers are from various issues of Report on Trends and Progress of banking in India.


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