[Dec 2007, Volume 4 Quarterly Issue] Pdf File size - The IIPM Think ...

MORE MARKETS, LESS GOVERNMENT
in 2004. The general perception is that
if the government reduces SLR the reduced
demand for government bonds
will lead to a rise in interest rates the
government has to pay bond holders.
This may adversely affect the fiscal
deficit. However, banks have continued
to invest around 40 percent of their deposits
in government securities in spite
of the reduction in SLR. This is essentially
because government bonds are
considered to be a risk-free investment
for banks.
Interest rates were deregulated in
1992 leading to complete liberalization
of all term deposit and lending rates,
except for savings deposit rates which
remain controlled. The RBI has also
begun using the bank rate (the rate at
which RBI lends to commercial banks
Table 4: Regulatory Framework Of Indian Banking Sector
Variable 1992-93 2000-01 2001-02 2002-03
Capital to Risk-weighted Assets
Ratio (%)
Domestic banks with international
4 9 9 9
business
Foreign banks 8 9 9 9
Non-performing assets
(period overdue)
Sub-standard assets 4 Q 2 Q 180 days 180
days*
Doubtful Assets
period for which remained substandard
24 M 18 M 18 M 18 M@
Provisioning requirements (%)
Standard Assets - 0.25 0.25 0.25
Sub-standard assets 10 10 10 10
Doubtful Assets (unsecured portion)
100 100 100 100
Loss assets 100 100 100 100
Source: RBI (2003d)
M: Month ; Q: Quarter
by rediscounting bills or eligible paper)
as a reference rate for influencing the
direction of interest rates in the economy
(Bhide et al., 2001). The flexibility
to set lending rates led the banks to use
this measure to offset the cost involved
in concessional lending to priority
sectors. During the reform period the
ceiling of 40 percent on domestic banks
and 33 percent on foreign banks for priority
sector lending remained but banks
were allowed to set the lending rates
and more profitable sectors like the
software industry and venture capital
were included in the definition of priority
sectors. The government relaxed the
norms for entry in the banking sector in
The deregulation of interest rates is also incomplete. Interest
rates on saving deposits and other saving schemes
such as National Savings Certifi cates, public provident
funds etc. remain regulated. Such rigidities reduce the
effectiveness of the transmission of monetary policy
order to increase competitiveness. For
example the ceiling of voting rights of
an individual shareholder was increased
from 1 to 10 percent in 1994. The relaxed
guidelines led to the entry of 8
private sector banks and 26 new foreign
banks in the Indian banking sector.
In response to the Narsimhan Committee
recommendations, the government
gradually started to privatize PSB.
These banks were accumulating large
amounts of NPA due to the pre-reform
regulated regime. They made an aggregate
loss of Rs.35 billion and almost
half of the public sector banks had negative
net worth. Realizing the importance
of recapitalization, the government
spent in the range of 0.02 to 0.7
percent of GDP each year to wipe off
accumulated NPA (Table 2). This
helped the banks clean up their balance
sheets and make public issues of equity.
As Table 3 shows, the central government
still continues to hold a large
share of holdings in major state-owned
banks. 6 Adoption of regulatory and supervision
norms: Strengthening of the
regulatory and supervisory framework
of the banking sector remains a key element
of financial sector reform. The
THE INDIA ECONOMY REVIEW
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