Financial Sector

From Laissez Faire to Government Control

• RBI was founded in 1935
• In 1947, India had 97 scheduled private banks, 557 “nonscheduled” (small)
private banks and 395 cooperative banks
• 14 private sector banks were nationalized in 1969 and 6 more banks were
nationalized in 1980
• Four other financial institutions except commercial banks: development
finance institutions (DFIs), co-operative banks, regional rural banks and
post-offices
• In 1990, RBI and government stopped refinancing DFIs as nonperforming
assets increased. As a result, IDBI and ICICI have been converted into
commercial banks, and the IFCI is effectively non-functional. NABARD, NHB
and SIDBI are continuing largely as refinance institutions with support from
the government
• Regional Rural Banks (RRBs) were established in 1975 as local level
banks in different states of India. They are co-owned by the Central
and State Governments and are structured as commercial banks
• Post Office Savings Bank (POSB) has a customer base of about 330
million account holders as on March 2015. They offer only deposit
and remittance facilities but not any credit to account holders
• Bombay Stock Exchange, the first stock exchange in India, was
founded in 1875
• LIC enjoyed a monopoly in the insurance business till the late 1990s
when the Insurance sector was opened to the private sector. General
insurance business was nationalized later in 1972 when 107 insurers
were amalgamated and grouped into just four government owned
companies
• By 1980s, the financial sector in India was virtually owned by the
government with nationalized banks and insurance companies and a
single public sector mutual fund
Banking in India since the 1990s
• Narasimham Committee recommended reduction of CRR and SLR and
a gradual elimination of the administered interest rate structure. It
also recommended modernizing the banking sector through better
regulation and supervision, and introduction of prudential norms
• Other suggestions: dismantling of the complex administered interest
rate structure to enable the process of price discovery; providing
operational and functional autonomy to public sector institutions;
preparing the financial system for increasing international
competition; opening the external sector in a calibrated manner; and
promoting financial stability in the wake of domestic and external
shocks
• There has been a reduction of CRR from 15% to about 4% and
reduction in the SLR from nearly 40% to 21.5% between the early
1990s and the mid-2010s have made a huge improvement to the
availability of lendable resources to the banking sector
• RBI has used repo rate as an instrument of effective control of
overnight liquidity
• Private sector commercial banks were licensed in the mid-1990s, the
first time since bank nationalization, in order to introduce
competition, enhance efficiency and induce innovation in the banking
sector
• Technology has enabled more effective, lower cost and real-time
delivery of financial services, through the establishment of a modern
payments system
• There has been an upward trend in aggregate deposit and credit as a
percentage of GDP. Profitability, efficiency and stability indicators of
commercial banking in India improved
• Increasing demand for automobiles, two wheelers and other
consumer durables promoted overall economic growth in the country
• Gross non-performing loans as a percentage of gross advances came
down steadily from 15.7% in 1996 to 2.4% in 2009
• Public sector banks were allowed to raise funds from the market
through equity issuance subject to the maintenance of 51% public
ownership
• The share of public sector banks continued to decline gradually in
banking business and a private sector bank emerged as the second
largest bank in India
• Indian banking sector continued to remain predominantly public in
nature. Public sector banks still accounting for more than 70% of total
banking sector assets
• During 2014–15, despite their substantive share in total assets, public
sector banks accounted for only 42% in total profits down from 74%
in 2003–04
• Decline in Gross NPAs (percentage of gross advances) of Indian banks
from 15% in 1998 to 3.3% in 2009 but it increased to 5.1% by the end
of 2015
• The stressed assets (i.e. gross NPA plus restructured standard assets
plus written off accounts) for the banking system as a whole
increased from 9.8% in 2012 to 14.5% in 2015; stressed assets in
public sector banks increased from 11.0% to 17.7% during the same
period
• The industrial sector—primarily the infrastructure and steel sectors
that have experienced greater deterioration in asset quality leading to
NPAs. Reasons: sharp fall in commodity prices has led to sharp
declines in the profitability of sectors such as steel that led to unpaid
debt to banks
• Steps for financial inclusion: postal savings bank, rural and urban co-
operative banks, regional rural banks and the nationalization of
banks, Pradhan Mantri Jan-Dhan Yojana
• Priority sector lending: agriculture; micro, small and medium
enterprises; export credit; education; housing; social infrastructure;
renewable energy; and others (like weaker section of the community)
• Indian commercial banks are required to lend 40% of their credit to
the priority sector
• Non-institutional sources (i.e., sources of credit other than
government, banks, insurance companies, pension funds, financial
companies, and so on) continued to play a major role in providing
credit to the rural households
• About 19% of all rural households have acquired credit from non-
institutional sources while for urban households about 10% by non-
institutional agencies
• By July 2016, over 230 million new bank accounts were opened and
Rs. 400 billion was deposited under the scheme of Pradhan Mantri
Jan-Dhan Yojana
• Payments banks: Established in 2015. They are narrow banks without
any lending activity. They can offer debit cards
• Small finance banks: They supply credit to small business units (such
as, small and marginal farmers; micro and small industries; and other
unorganized sector entities) through high technology-low cost
operations. 50% of their loans should be of under Rs. 2.5 million
• Bank licenses are NOT issued to non financial big industry houses but
payments banks licenses were issued to some big industry houses as
they are not permitted to do any lending
Insurance Sector
• Reform started in 1993
• Insurance Regulatory and Development Authority (IRDA) was
established
• Private sector players were allowed to enter the insurance sector
• As of March 2015, this sector comprised 24 life insurance companies
and 28 general insurance companies, and one national reinsurer
• LIC holds a lion’s share in insurance business
• The general insurance business is 2.1% in the global life insurance
business and 0.7% of GDP – biggest in terms of number of policy
holders (360 million policies)
Equity Market
• Financial scam in 1992 led to more strict regulatory guidelines in 1996
• SEBI, the securities market regulator, was established in 1988, it was
given statutory powers in April 1992 through the SEBI Act, 1992
• BSE was established in 1875 and NSE in 1992
• India’s market capitalization has been growing continuously
NBFCs
• NBFCs:
a) cannot accept demand deposits
b) do not form part of the payment and settlement system and cannot
issue checks drawn on itself
c) don’t not have deposit insurance facility
• They have been very useful for sectors / activities that are generally
excluded from formal banking activities
• Deposits of NBFCs as a proportion of bank deposits were 0.8% during
1985–86 to 1989–90, they shot up to as much as 9.5% by 1996–97 as
they offer high rates of interests
• RBI has the power to regulate NBFCs
• Chit Funds are regulated by the State Governments, and Mutual
Benefit companies are regulated by Ministry of Corporate Affairs,
Government of India
• With the increasing regulatory control acceptance of deposits by the
NBFCs had come down
• The ratio of NBFCs’ assets in GDP increased steadily from just 8.4% in
2006 to 12.9% in 2015 while the ratio of bank assets increased from
75.4% to 96.4% during the same period
• Future areas for development in the Indian financial sector would
include further reduction of public ownership in banks and insurance
companies
• Rapid expansion of the insurance coverage, greater spread of mutual
funds, and development of institutional investors