Indian Commercial Banking Services: Key Policy Perspectives in the Post-Reform Period (1991-2009)

By Khanna, Perminder | Political Economy Journal of India, July-December 2012 | Go to article overview

Indian Commercial Banking Services: Key Policy Perspectives in the Post-Reform Period (1991-2009)


Khanna, Perminder, Political Economy Journal of India


Introduction

The conventional wisdom about the stages of the development process suggests that an economy evolves from being agriculture-dominated to industry-dominated, and then to services-dominated. History suggests that the dominance of the services sectors is unlikely to be sustained without the strong growth of industry and agriculture.

The Indian growth experience however negates the Rostowian stages of growth hypothesis, since transition in India has been marked by the rapid movement from agriculture-dominated growth to services-dominated growth bypassing the stages of industry-dominated growth. The high income elasticity of services indicates that as real per capita income rises, the quantity demanded of commodities exceeds its supply. Trade liberalization and reforms have also positively impacted the growth of services, the share of which has gone up from 55.8 per cent to 64.5 per cent of Gross Domestic Product (GDP) during 200009. Therefore, it is considered that to promote higher economic growth and to provide a stable macro-economy, the financial systems of the developing countries must function effectively and provide the full range of financial services.

The importance of finance in the growth of the economy is due to:

* Mobilizing savings;

* Allocating capital funds;

* Monitoring managers, and

* Transforming risk.

The paper titled "Indian Commercial Banking Services: Key Policy Perspectives in the Post-Reform Period (1991-2009)" focuses on a critical analysis of financial deepening by the commercial banks in the various sectors of the economy during the eighteen year period.

As a result of banking deregulation, banks today like most other firms in the economy set their own interest rates and vigorously compete with one another for depositors and loan customers. These recent changes consequent upon the liberalization and globalization of international economic environment have been examined at length, together with the focus on the nature and uses of bank funds and on the optimal mix of assets and liabilities consistent with the conflicting objectives of safety and earnings.

Methodology

The focus of the paper being on the economic viability and performance of commercial banks comprising public, private and foreign banks in the post-liberalization era, a reference period of eighteen years (1991-2009) has been taken up. To capture the concept of development in the banking sector after the initiation of financial sector reforms in 1991-92, a set of measures imperative for effective policy formulation, implementation and evaluation have been used.

The first measure is the Sectoral Deployment of Bank Credit denoted by BCRD which is a primary indicator of financial sector development. This is equal to the ratio of value of credit by financial intermediaries to the various sectors to GDP. This measure concentrates on credit issued by commercial banks other than the central bank and gives the degree of financial intermediation and measures the financial resources provided to the different sectors through loans, trade credit, export credit, etc.

The second measure of financial development, the ratio of Broad Money (M3) to GDP denoted as BDM is defined as currency plus demand and interest bearing liability of the financial and non-bank financial intermediaries as a percentage of GDP. BDM is the broadest available indicator of financial intermediation, since it includes all the three financial sectors, viz. central bank, commercial banks and other financial institutions. It is a typical measure of financial 'depth' and thus the overall size of the financial sector.

A Case for Financial Liberalization

The process of financial liberalization has drawn its intellectual inspiration from the pioneering works of Ronald Mc Kinnon and Edward Shaw in the early seventies. They discussed as did Maxwell Fry later, the impact of what was termed 'financial repression' on economies as a result of extensive controls on the functioning of the financial system and argued the case for financial liberalization as a means to further economic growth. …

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