Bargains and Banking: How Institutionalized Political Bargains Have Shaped the Development of Indian Banking

Abstract This essay shows how the sectoral political network in India’s banking sector has structured its development, from the era of dirigisme beginning under the Nehru government in 1947, to the more liberalized contemporary period starting in 1991. We show that political bargains, or institutionalized agreements among actors in a sectoral political network, are mechanisms through which the legacies of earlier eras shape developments in subsequent periods. Our study of India’s banking sector examines two varieties of political bargains. Politicians created an entrenched political bargain during the dirigiste era by nationalizing India’s banks to assert control over bank governance. Entrenched bargains limit subsequent reforms to policies that address their negative consequences but not the underlying causes emanating from the interests of powerful actors. Principal-agent relations are the second type of political bargain. Politicians struck this evolving bargain by establishing an asymmetric relationship between the government and India’s central bank, the Reserve Bank of India (RBI). We analyze how these entrenched and principal-agent bargains have shaped the development of Indian banking by examining their impact on the banking sector’s recurring non-performing asset problem and its dynamic payment system.