Indian Financial Market - Essay Example

Indian Financial Market Deregulation of the banking sector, which is a vital component of financial liberalization, greatly enhances the scope of speculative activities and exposes the financial system to the risks associated with volatile capital flows. This lesson was painfully learnt by several developing countries through the decade of the nineties. Far from contributing positively to economic growth, asset creation and employment generation, financial liberalization has precipitated crises in several countries. However, the RBI’s Report on Trend and Progress of Banking in India 2003-04, talks about the appropriate timing of the entry of foreign banks into India so as to be co-terminus with the transition to greater capital account convertibility (Thankur, 1990). This shows that the economic policy establishment in India, including the RBI, has not drawn adequate lessons from the experiences of the financial crisis-affected countries. Besides, banks are the principal risk carriers in the system, taking in small deposits that are liquid and making relatively large investments that are illiquid and can be characterised by substantial income and capital risk. The observed tendency among some promoters or boards of banks to divert a substantial share of its deposits into speculative activities in which the promoter or board may be interested or into investments that are risky but promise quick returns, can increase financial fragility, lead to bank failures and if the magnitude of the failure is serious enough, can actually precipitate crisis for the entire financial system (Thankur, 1990). Instances in India such as the Nedungadi Bank and the Global Trust Bank are the harbingers of what may follow if reckless deregulation of the banking sector is carried out. In fact, the experience of recurrent financial crises in the 1990s, most famously the East Asian experience, has shown how banking deregulation along with capital market liberalization often serves as recipes for financial turmoil in developing countries (Desai, 1987). Many guidelines have stated among other things that no single entity or group of related entities would be allowed to hold shares or exercise control, directly or indirectly, in any private sector bank in excess of 10 % of its paid-up capital. Recognising that the 5th March notification by the Union Government had hiked foreign investment limits in private banking to 74%, the guidelines sought to define the ceiling as applicable on aggregate foreign investment in private banks from all sources (FDI, Foreign Institutional Investors, Non-Resident Indians), and in the interest of diversified ownership, the percentage of FDI by a single entity or group of related entities was restricted to 10% (Desai, 1987). A hike in the foreign equity cap in banking would create an “enabling environment” for higher FDI flows, leading to “infusion of new technology and management practices” resulting in “enhanced competitiveness”. However, the Left Parties feel that neither does raising of the equity cap ensure higher FDI inflows, nor does higher FDI inflow necessarily imply infusion of such technology and management practices that are beneficial to the economy and the people. What is more, it can curb rather than enhance competitiveness, especially when a regulatory framework meant to ensure diversified ownership is diluted to pave the way for foreign banks acquiring private Indian banks within three to four years through creeping acquisition (Garg, 1989). While it is true that the gross and net NPAs as a percent of total assets or as a percent of gross or net advances have shown a gradual decline over the last few years, the absolute values of gross or net NPAs have continued to rise for almost all categories of banks. This cannot be interpreted as a sign of growing strength of the banking sector. Moreover, if one further considers the fact that the trend towards window dressing balance sheets in the name of NPA management has grown considerably among all banks, including those in the public sector, the claim of growing efficiency and strength of the banking sector becomes even more suspect (Garg, 1989). Over the past few years there has been a steady decline in interest rates largely reflecting sustained reduction in inflation rates and inflationary expectations. Such reductions in interest rates occurred in an environment where credit growth remained sluggish. Consequently, there was a favourable impact on banks’ balance sheets in terms of increased operating profits from treasury operations given the asset concentration in favour of Government securities in excess of the requirement of statutory liquidity ratio (SLR) (Desai, 1987). The only point, which remains to be added in this context, is that the lure of high profits from treasury operations is attracting foreign banks towards India today; which has dovetailed with the possibility of making quick gains by the promoters of private Indian banks by selling off their stakes to foreign banks and FIIs while their balance sheets look good; to create a pressure group which wants further opening up of the banking sector. There is no good reason why the UPA Government should frame policies to cater to the needs of such pressure groups (Thankur, 1990). While the impact of the implementation of the banking reforms in the 1990s in terms of increasing the efficiency and strength of the banking sector remain suspect, what has been unambiguous is its immediate, direct, and dramatic effect on rural credit, which the Left considers to be one of the key parameters to judge the efficacy of the banking system. There has been a contraction in rural banking in general and in priority sector lending and preferential lending to the poor in particular. Loans to multinationals involved in agribusiness like Pepsi, Kelloggs, Hindustan Lever and ConAgra now count as priority sector advances (Thankur, 1990). The proposal to dilute stakes of Public Sector Banks upto 33%, which was recommended by the Second Report of the Narasimham Committee, had failed to gain Parliamentary approval. It was because the Parliament felt at that time that the process of banking deregulation and financial liberalization has already gone too far in India. The RBI itself has found through its empirical studies that there is no observable link between ownership and efficiency or profitability, as far as the Indian banking sector is concerned (Thankur, 1990). Until almost the middle of the last decade the financial system was highly regulated. Although the DFIs were given freedom to extend term loans to projects, which they considered support-worthy based on their rigorous technical and financial appraisal, their interest rate structure was administratively fixed by the RBI along with the other interest rates in the system. The interest rates charged by the commercial banks were appropriately aligned in such a way that the project loans were relatively lower than the loans extended by banks for such purposes as working capital for industrial and other units (Thankur, 1990). Similarly, the rates that the corporate entities could offer on their bonds were fixed by the Finance ministry, which used to regulate the capital markets until the independent capital market regulator viz., Securities Exchange Board of India (SEBI) was set up about a decade ago. The Finance Ministry, however, used to informally consult RBI before it fixed the interest rates on corporate bonds. Usually the interest rates on bonds and the interest rates of the DFIs were such that the corporate units did not have much attraction to raise funds from the market (Thankur, 1990). There were other factors, which also discouraged corporate sector raising funds directly from the market. The debt-equity norms on bond funds were more rigorous than the ones that the institutions allowed in respect of their term loans. While the Finance Ministry did not permit bond issues of companies that would exceed the debt-equity ratio of 2:1, the institutions used to extend loans that would result in a debt-equity of up to 3:1 in respect of highly capital-intensive projects (Thankur, 1990). Furthermore, for the common investors corporate debt was not attractive in view of the absence of a secondary market for corporate debentures. Another highly discouraging factor was the high level of stamp duty that the state governments levied on secondary market transactions in bonds. On account of all these discouraging factors corporate bond market did not develop and the corporate borrowers preferred to raise funds by approaching term lending institutions (Thankur, 1990). Table 1. Market Capitalisation of WDM Segment as on April 30, 2001 Security type Market Capitalisation (Rs. Billion) Share in total (%age) Govt. Securities 4241.61 69.61 PSU Bonds 361.99 5.94 State Loans 450.95 7.40 MF Units 375.64 6.16 Fin. Institutions 278.19 4.57 Treasury Bills 186.67 3.06 Corporate Bonds 149.94 2.46 Others’ 48.74 0.80 Total 6093.73 100.00 Trade in WDM Sector S. No. Particulars 1999-2000 2000-2001 1 Number of trades 46,987 64,470 2 Turnover (Rs. billion) 3402.16 4285.82 3 Average trade size (Rs. million) 64.70 66.50 4 Average daily turnover (Rs. billion) 10.35 14.83 5 Average daily number of trades 160 223 6 Number of active scrips 1,057 1,038 7 Number of active members 50 48 8 Number of active participants 85 88 The same developments have been formulated in the pesion function of the Indian financial sector. For a long time it has been clear that the Central and State governments cannot sustain their open-ended pension schemes. The pension amount is now linked to the last drawn pay of the employee. Rapidly improving life expectancy coupled with mismanaged public finance at the States level has raised serious question marks over funding their pension fund liabilities. Many public finance experts think that the issue may take crisis proportions in the near future (Thankur, 1990). The new regulators first task is to prepare the ground for a drastic overhaul of the government pensions scheme. Already Central government employees who joined after January 1 last year (some 40,000 of them) have technically joined the new pension scheme. An interim regulator, a Central government servant, has been overseeing the scheme, but without any real powers. Again, purely on an ad hoc basis the corpus of the fund was earning 8 per cent interest. Such an arrangement was certainly not intended to be permanent but any meaningful change had to wait for the arrival of an independent regulator. The thrust this time is on "defined contribution in contrast to "defined benefit under the existing pension schemes for government schemes. Each employee will open an individual account with one of the pension funds and contribute 10 per cent of the salary and DA every month during his or her working life. This will be matched by the Government (Thankur, 1990). Works Cited Desai, V. 1987. Indian Banking: Nature and Problems. Himalaya Pub. House Garg, S.C. 1989. Indian Banking, Cost and Profitability. Anmol Publications Thankur, S. 1990. Two Decades of Indian Banking: The Service Sector Scenario. Chanakya Publications Read More