Yet, India has been among the slowest of emerging markets to privatise banks. This research and recent events suggest several reasons politicians may be reluctant to give up control of public sector banks. Increasing public sector bank lending prior to elections does not require the passage of any law, and can be targeted relatively precisely, in contrast to state or national initiatives. Even if the creditor eventually defaults, the politicians may not need to explicitly budget for the cost, hoping instead that other bank business can subsidise the loans, or that any necessary recapitalisation can be deferred until long into the future. Finally, unlike improved schools or better roads, bank loans can be delivered quickly, with the recipient fully confident of their value.

What should India do? I am reluctant to issue policy prescriptions. There is no question that the strictness of the RBI and other regulatory authorities has limited volatility in the financial sector. But in light of the substantial degree of public interference in lending, advocates of keeping the banking sector in government hands should explain how they will ensure politicians do not meddle in bank affairs, and why regulation cannot work for private sector banks.

The writer is an assistant professor at Harvard Business School where his research focuses on corporate finance in emerging economies

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