Researcher: Class: Roll No:: Tsering Dolma B. A. Programme, 2 Year 3412

Researcher: Tsering Dolma
Class: B. A. Programme, 2nd

year
Roll no: 3412
Topic: Banks and their effects

on financial sector
development and economic
development..
Abstract: Financial system play a

crucial role in the economic development
of a country. There is sufficient economic
literature, which reveals that a well
functioning financial system increase
economic efficiency, investment and
growth. This paper provides a snapshot of
the evolution of indian financial system
along with its progress and performance
by making use of various proxy variables
of financial development. It also attempts
to examine the relationship between the
financial development and growth in
indian context. By using time series data
from 1991 to 2012-203 period and using
three proxy variable viz GDP for economic
growth of india, m2 to GDP ratio and ratio
of stock market capitalization to GDP for
measuring the extent of financial
deepening in India and utilizing regression
technique, the empirical findings very
clearly point towards the existence of
strong relationship between financial
deepening FD and EG. The paper also
shows the extent of financial deepening of
markets in India vis-a-vis other Asia Pacific
economic. The analysis reveals that the
indian financial sector has undergone far
reaching changes over three and half
decades as a result of financial sector
reforms. Consequently, the widening and
deepening of financial system has allowed
greater and more productive investment
to occur. Financial intermediation has
increased over time, which in turn is
leading to a virtures cycle of higher
savings, improved investment efficiency
and higher real economic growth.
However, there are several challenges in
the financial sector in the form of
increasing non-performing assets of the
banks underdeveloped corporate bond
market. These challenges need attention
and require policy intervention.
Keywords: Credit facilities, Gross
Domestic Product, Customer deposits,
interest rate, Financial development,
Economic growth, the legal system and
empact etc.
Introduction: Since the beginning of

the 1990’s, the Indian Economy has been
undergoing economic reforms which
include financial sector reforms among
others. Financial sector reforms mainly tell
us about the reforms of the banking
system and the capital market. With
deregulation of the interest rate Indian
banking system has become more market
oriented since 1991.There has been a
rapid expansion of the stock market
activities as well. The number of stock
exchanges increased from 9 in 1981 to
22in 1991. The number of listed
companies increased from 2265 in 1980 to
6229 in 1991. And, market capitalization
increased from 68 billion rupees in 1980
to 1103 billion rupees in 1991 and to
11926 billion rupees in 2000.
Financial sector reforms in India were
introduced as a part of the economic
reform programme initiated in 1991.The
principal objective of financial sector
reforms was to improve allocative
efficiency of resources, ensure financial
stability and maintain confidence in the
financial system by enhancing its
soundness and efficiency. In August
1991,the Indian Government appointed
the Narasimham Committee to look into
all aspects of the financial system and
make comprehensive recommendations
for reforms. The committee submitted
the report in November 1991,
recommended various reform measures
for the banking sector and the capital
market. Interest rates on time deposits
were deregulated gradually. However, the
rate on savings deposits remained
controlled by the Reserve Bank of India.
Lending rates were also decontrolled. The
Reserve Bank of India now controls only
the interest rate charged on Export credit,
which accounts for only 10 percent of
commercial advances.
Since the reform of 1991,some
liberalization measures have been taken
on the cash reserve ratio (CRR) and
statutory liquidity ratio (SLR). Before 1991,
the CRR was as high as 25 percent and the
SLR was 40 percent. The CRR has come
down to 6 percent in 2006-07 and the SLR
is 25percent at present.
Another important feature of the reforms
is that, since 1991,a number of foreign
banks and private entrepreneurs were
invited to commence banking operation in
India. To enhance competition, foreign
direct investment upto 74 percent of
Ownership has been allowed in private
banks and upto 20 percent in nationalized
banks. The number of foreign and private
banks operating in India have increased
from 21 and 23 in 1991 to 33 and 30 in
2004,respectively.
Any discussion on reforms in the Indian
banking system will remain incomplete
without mentioning the regulatory reform
introduced since 1991.Before 1991,Indian
banking system did not allow uniform
accounting practices for income
recognition, classification of assets into
performing and non performing.
Capital market reform was an integral part

of the agenda of financial sector reforms
in India. The oldest stock exchange in
India-the Bombay stock exchange (BSE) –
started its operation in 1875.It started
expanding rapidly since 1980.
In 1993,the Indian capital market was

opened up to foreign institutional
investors (FIIs) and Indian companies were
allowed to raise capital abroad by issue of
equity in the form of global depository
receipts (GDRs).
Another major reform measure in the
Indian capital market was the set up of
the National Stock exchange (NSE) in 1994
with nationwide stock trading and
electronic display and clearing and
settlement facilities.
Finally, a major change in relation to the
secondary market was that the settlement
period was reduced to one week. At the
same time carry forward trading was
banned and then reintroduced in
restricted form and moves were made
towards a rolling settlement system.
Review of Literature:
There are various strands of literature
exploring various aspects of the link
between finance and economic
development. The first among them
pertains to the relationship between
financial structure and economic
development. Gurley and Shaw (1955)
view that at low levels of development
commercial banks are the dominant
financial institutions. Goldsmith (1969) he
evaluated the relative merits of bank-
based and market based financial systems
and their impact upon economic
development. Harvey (1989)he analyzed
the forecasting capacity of stock and bond
prices for GNP growth rate. He found that
information about economic growth can
be drawn from both bond market and
stock market variables. A large body of
cross country and country level studies
are made in this line following the seminal
works by King (1990) .And, most of them
concluded that financial market in general
and stock markets in particular positively
contributes to economic growth through
the provision of these services. Levine
(1991) studied the impact of stock
markets on economic activity through the
creation of liquidity. Berthemely and
Varovdakis (1994) made a novel attempt
to find out the reciprocal interaction
between financial and real sectors in the
economy in the context of multiple steady
state equilibrium. Obstfeld (1994)
examined the impact of risk diversification
through internationally integrated stock
markets on economic growth. Bencivenga
et al (1995) he studied the impact of the
efficiency of an economy’s equity market-
as measured by the cost transacting in
them, affects the economy’s efficiency in
producing physical capital and through
these channel final goods. Demirgiic -kunt
and Levine (1996) made a pioneering
study using data from both industrial and
developing countries. Their study supports
the study of Gurley and Shaw .Boyd and
Smith (1996) studied the co-evolution of
the real and financial sectors of the
economy as it develops. They argued that
financial innovation is a dynamic process
that both influences and is influenced by
the real sector. Fase and Abma (2003)
examined the empirical relationship
between financial development and
economic growth in South East Asia using
data for twenty five years. They found
that financial development matters for
economic growth and that causality runs
from financial structure to economic
development. Beck, Demirgiic-kunt and
Levine (2004) show that financial
development exerts a positive impact on
the poor and reduce income inequality.
Objectives of Study:
A. The central objective of the study
to empirically investigate the role
of Indian banks in capital
formation and economic growth.
B. To analyze the impact of Banks
deposit mobilization of capital
formation and economic growth
in India.
C. To determine the association
existing between capital
formation and economic growth
in India.
D. This study portrays how loans and
credit affect the GDP and
consequently the level of
economic growth in India.
E. The main objective of this study is
to assess the mechanism that
relates financial sector
development to economic
growth.
Data and methodology:

The study makes use of
secondary sources of data like
books and publications of Reserve
Bank of India (RBI), Securities and
exchange Board of India (SEBI)
and Asian Development Bank
(ADB). It has made use of
statistical techniques like
percentages, ratios and
regression analysis. The
performance of Indian financial
system has been analyzed using
few dimensions of the money
markets especially that of
scheduled commercial banks
(SCBs). The study also makes use
of 22 years time series data from
1991-91 to 2012-13 and
regression technique to examine
the relationship between
financial sector development and
economic growth.
Analysis:
A. Manufacturing credit and
manufacturing GDP have a
long term co-integration
relationship. This relationship
is significant at the
5%level.Broader variables of
industrial credit and industrial
GDP however are not co-
integrated.
B. GDP leads credit for the
Industrial and manufacturing
sectors as per granger
causality test.
C. The overall GDP data at a
macro-level exhibits a
structural break at 1992.The
credit and GDP data has been
split into two series 1,(1951-
1992) and 2.(1993-2014)
D. The main aim of this study
was to investigate the role of
Indian banks in capital
formation and economic
growth.
ADVANTAGES OF BANKS:
1.Safety of public wealth
2.Availability of cheap loans.
3.Propellend of economy.
4.Development in rural areas.
5.Economies of large scale.
6.Global reach.
DISADVANTAGES OF BANKS:
1.Chances of bank going
bankrupt.
2.Risk of fraud and robberies.
3.Risk of public debt.
The development of any

country depends on the
economic growth of the
country achieves over a period
of time. Economic growth
deals about investment and
production and also the
extent of Gross Domestic
Product in a country. Only
when this grows, the people
will experience growth in the
form of improved standard of
living, namely, economic
development.
Conclusion:
The study tells us about the
relationship between credit
and GDP for different sectors
of the indian economy. An
attempt has been made to
estimate whether a long term
co-integration relationship
exists between credit and
GDP. The study also tries to
identify if a casual relationship
exist between credit and GDP
and the direction of the
causality. Johansen test and
Granger causality test was
used to study the relationship
between the variables.
However, a short term causal
relationship with GDP credit
exists for the sectorial as well
as overall data.
References:
Bencivenga et al (1995) –“The
determinants of stock market
in Ghana”
Boyd and Bruce Smith (1996)

–“The co-evolution of the real
and financial sectors in the
Growth process”.
The world bank Economic
Review
Volunteers. 10,No.2, A
Symposium Issue on Stock
Beck, Demirgiic-kunt and
Levine (2004) –“Finance,
Inequality, and Poverty:Cross-
Country Evidence”.
Fase and Abma (2003) –

“Financial environment and
economic growth in selected
Asian countries”
Journal of Asian Economies,
2003,vol.14, issue 1,11-21.
Gurley and Shaw (1955) –

“Financial aspects of economic
development”.
Goldsmith (1969) –“Financial

structure and Development as
a subject for International
comparative study”.
Harvey (1989) -“The condition
of Post Modernity”.
Levine (1990 and 1991)

_“Financial structure and
economic
development”and“The journal
of finance”.
Obstfeld (1994) - “The logic of

currecy crises”.

Researcher: Class: Roll No:: Tsering Dolma B. A. Programme, 2 Year 3412

Uploaded by

Copyright:

Available Formats

Researcher: Class: Roll No:: Tsering Dolma B. A. Programme, 2 Year 3412

Uploaded by

Document Information

Original Description:

Original Title

Copyright

Available Formats

Share this document

Share or Embed Document

Sharing Options

Did you find this document useful?

Is this content inappropriate?

Copyright:

Available Formats

Researcher: Class: Roll No:: Tsering Dolma B. A. Programme, 2 Year 3412

Uploaded by

Copyright:

Available Formats

Researcher: Tsering Dolma

Class: B. A. Programme, 2nd

Topic: Banks and their effects

Abstract: Financial system play a

Introduction: Since the beginning of

Capital market reform was an integral part

In 1993,the Indian capital market was

Data and methodology:

The development of any

Boyd and Bruce Smith (1996)

Fase and Abma (2003) –

Gurley and Shaw (1955) –

Goldsmith (1969) –“Financial

Levine (1990 and 1991)

Obstfeld (1994) - “The logic of

You might also like