The role of public sector banks in India

Government control of banking assets, achieved through public sector banks (PSBs), is a feature of many economies. Do “developmental” or “sociopolitical” considerations drive PSB lending? To address this question, we study the loan allocation and asset quality of PSBs using comprehensive data on bank transactions in India from 1999 to 2018. We show that PSBs held the bulk of non-performing assets (NPAs) in India and that most of these were concentrated in infrastructure sectors. These stressed sectors exhibited counterintuitive relationships between productivity, loans, and NPAs. They also had high capital and labor misallocations. Using the infrastructure-oriented fiscal stimulus bill after the 2008 financial crisis as a natural experiment, we find that post-2008 there was: (i) increased lending to infrastructure sectors by PSBs; (ii) reduced lending to infrastructure sectors by private banks; and (iii) a disproportionate growth in NPAs among PSBs. Taken together, our results suggest that PSB lending is driven by both “developmental” and “sociopolitical” goals.