Targeted lending by public sector banks higher in swing districts

Lending by public sector banks (PSBs) tracks the state-level electoral cycle and targeted lending has been particularly high in swing districts where the winning margin in the previous election was small , according to an RBI panel, referring to research on the political nature of lending.

Clearly, such politically induced lending fails to increase production but aggravates loan delinquency, said the PJ Nayak committee set up to review governance of boards of banks.

“Referring to a paper — ‘Fixing market failures or fixing elections? Agricultural Credit in India’ — in the American Economic Journal (Applied Economics), the committee said it demonstrates that in districts where the margin of victory for the state-level incumbent party in the previous election was very narrow, directed lending by PSBs in the election year increases by 9 per cent compared to any of the earlier four years.

Other countries too Evidence for such politically induced lending by Government banks comes also from 43 countries, including India, Pakistan and Brazil.

According to the Nayak committee, several decades of running its banks in a Government-as-Sovereign role has resulted in acute financial stress for banks (PSBs) and falling market share.

Further, it has also resulted in deeply negative financial returns for the Government, and also led to bank boards getting disempowered.

Despite its many historical benefits of expanding the reach of the banking sector, the committee observed that it is difficult to argue today that the Government’s style of running its banks is serving either the Government or the banks well.

In addition, this style of controlling banks also leads to suasion, wherein several arms of the Government issue informal oral instructions or proffer advice which may never be put on official record. It is thereby very easy for such a style of control to deeply politicise bank governance.

“When such suasion also extends to loan sanctions, often at the behest of corporates and other borrowers, and spawns an informal profession of intermediaries hawking loan proposals to banks, the banking industry becomes deeply imperiled.

“Banks then get viewed as an extension of the fiscal arm of the Government rather than as purveyors of good quality credit. Government-as-Sovereign is a style of control that urgently needs to change,” the report stated.