Role Of Banks In Indian Economy Report

Role of Banks in Indian Economy

Macroeconomics Research Paper Prepared by : Sourabh Kumar Saha PGDM : 2008-2010 Calcutta Business School , West Bengal , India Email : [email protected]

Abstract: Banks play an important role in development of Indian economy. After liberalization, the banking industry under went major changes. The economic reforms totally have changed the banking sector. RBI permitted new banks to be started in the private sector as per the recommendation of Narasimham committee. The Indian banking industry was dominated by public sector banks. But now the situations have changed. New generation banks with used of technology and professional management has gained a reasonable position in the banking industry. In this paper we look at the type of banks , their role and functioning , Establishment and Role of India‟s Central Bank - RBI and the recent banking reforms . We perform a comparative data analysis between GDP and total advances & deposits . We also check whether the Credit Deposit Ratio has any relationship with the GDP . We then perform a regression analysis to check whether there is any relationship between GDP and Bank lending interest rates. We also compare the Flow of credit to Agricultural Sector with the Growth of Agriculture Sector. We conclude the analysis by an overview and analysis of the sectorial deployment of gross bank credit over the last two financial years.

Index Title 1. Introduction 1.1. Motivation 1.2. Hypothesis 1.3. What is a Bank 1.4 Functions of a Bank 1.5. Types of Banks 1.6. Banking Sector in India 2.0 Role of Banks 2.1. Role of Banks in Indian Economy 2.2. Role of Central Bank (RBI) 2.3. Evolution of Indian Banking 2.4. Narasimham Committee Banking Reforms 2.5. Performance of Indian Banking Sector Post Reforms 3.0. Methodology 3.1. Data Analysis 3.2. Remarks 3.3. The challenges Ahead 3.4. Conclusion References Acknowledgement

Page 3 3 4 4 4 6 7 8 9 9 10 10 12 15 15 25 26 26 27 28

1. Introduction Banks over the years, have become a significant aspect of an economy. With the ongoing financial depression, the position of banks have become all the more important in the course of working of the money market and hence the economy of a nation. The banking sector forming a portion of the financial sector primarily works as a financial intermediary generating money supply. From the different macro economic models , banks have been found to be a part of the supply side of the economy . However, over time banks have transformed from merely money generating organizations to a multi tasking entity. In this paper, we shall deal with the role of banks in the context of the world economy as well as the Indian economy . The first section will illustrate the functions of a bank along with its classification. In the second section, we shall discuss the role of a banks as a major component of the service sector rendering to the economy as a whole. In the third section, we would like to empirically validate our hypothesis with a comprehensive data analysis.

1.1 Motivation The recession in the US market and the global meltdown termed as Global recession have engulfed complete world economy with a varying degree of recessional impact. World over the impact has diversified and its impact can be observed from the very fact of falling Stock market, recession in jobs availability and companies following downsizing in the existing available staff and cutting down of the perks and salary corrections. Various steps taken by RBI to curb the present recession in the economy and counter act the prevailing situation. The sudden drying-up of capital inflows from the FDI which were invested in Indian stock markets for greater returns visualizing the Potential Higher Returns flying back is continuing to challenge liquidity management. At the heart of the current liquidity tightening is the balance of payments deficit, and this NRI deposit move should help in some small way. To curb the liquidity crises the RBI will continue to initiate liquidity measures as long as the current unusually tight domestic liquidity environment prevails. The current step to curb these being lowering of interest rates and reduction of PLR . The BOP- Balance of Payment deficit – at a time when domestic credit demand is very high – is resulting in a vicious loop of reduced access to liquidity, slowing growth, and increased risk-aversion in the financial system. In present situation down fall in one sector one day leads to a negative impact on the other sector thus all together everyone feel the impact of the Financial crises with the result of the current recession which started in US and slowly and gradually due to linked global world have impacted everyone. Solution for the problem still remain at the top of the mind of every one, still everyone facing the impact of recession but how long is the major question which is of great importance.

1.2 Hypothesis In this research paper , I am trying to give an overview of the whole banking sector in India and the kind of financial functions they perform which help in the growth of the economic growth and progress of the country . I have tried to look for relationship if any between GDP and the following : Total advances/Total deposits , Credit Deposit Ratio , Lending interest rates , and the sectors in India which got more advances from the banks over the last 3 years .

1.3 What is a Bank While the question may seem elementary, the answer can be quite complex. Understanding what banking is all about will help the paper to illustrate the role of banks better. A bank is a financial institution where an individual can deposit money. Banks provide a system for easily transferring money from one person or business to another. Using banks and the many services they offer saves an incredible amount of time, and ensures that the funds of micro as well as macroeconomic agents "pass hands" in a legal and structured manner. There are also other types of financial institutions that operate just like banks.

1.4 Functions of a Bank Functioning of a Bank is among the more complicated of corporate operations. Since Banking involves dealing directly with money, governments in most countries regulate this sector rather stringently. In India, the regulation traditionally has been very strict and in the opinion of certain quarters, responsible for the present condition of banks, where NPAs are of a very high order. The process of financial reforms, which started in 1991 has cleared the cobwebs somewhat but a lot remains to be done. The multiplicity of policy and regulations that a Bank has to work with, makes its operations even more complicated, sometimes bordering on illogical. This section attempts to give an overview of the functions in as simple manner as possible. Banking Regulation Act of India, 1949 defines Banking as "accepting, for the purpose of lending or investment of deposits of money from the public, repayable on demand or otherwise and withdraw able by cheques, draft, order or otherwise". Deriving from this definition and viewed solely from the point of view of the customers, Banks essentially perform the following functions : 1. 2. 3. 4. 5. 6. 7.

Accepting Deposits from public/others (Deposits) Lending money to public (Loans) Transferring money from one place to another (Remittances) Credit Creation Acting as trustees Keeping valuables in safe custody Investment Decisions and analysis

8. Government business 9. Other types of lending and transactions. In addition to providing a safe custodian of money, banks also loan money to businesses and consumers. A large portion of a bank's business is lending. How do banks get the money they loan? The money comes from depositors who intend to save a portion of their wealth. Banks acting as intermediaries, use these deposits as loans to prospective borrowers. The objective of commercial banks like any other organization is profit maximisation. This profit generally originates from the interest differential between borrowers and lenders. In the present day, however, the banking operation has extended much beyond simple lending exercise. So there are other different channels of profit ensuing from other investment programmes as well. However, it should be mentioned in this context that the entire deposit held by a bank cannot be given as loans as the Central Bank retains a portion of this money in the form of cash-reserve for unforeseen circumstances. Banks create money in the economy by making loans. The amount of money that banks can lend is directly affected by the reserve requirement set by the Federal Reserve. The reserve requirement is currently 3 percent to 10 percent of a bank's total deposits. This amount can be held either in cash on hand or in the bank's reserve account with the Fed. To see how this affects the economy, think about it like this. When a bank gets a deposit of $100, assuming a reserve requirement of 10 percent, the bank can then lend out $90. That $90 goes back into the economy, purchasing goods or services, and usually ends up deposited in another bank. That bank can then lend out $81 of that $90 deposit, and that $81 goes into the economy to purchase goods or services and ultimately is deposited into another bank that proceeds to lend out a percentage of it.

In this way, money grows and flows throughout the community in a much greater amount than physically exists. That $100 makes a much larger ripple in the economy than you may realize! Other Services Offered by Banks

o o o o o o o o o

Credit Cards Personal Loans Home and Car Loans Mutual Funds Business Loans Safe Deposit Boxes Debit Cards Trust Services Signature Guarantees

…and many other investment services.

1.5 Types of Banks Central Bank: A central bank, reserve bank, or monetary authority is the entity responsible for the monetary policy of a country or of a group of member states. Its primary responsibility is to maintain the stability of the national currency and money supply, but more active duties include controlling subsidized-loan interest rates, and acting as a lender of last resort to the banking sector during times of financial crisis (private banks often being integral to the national financial system). It may also have supervisory powers, to ensure that banks and other financial institutions do not behave recklessly or fraudulently. Commercial Banks : A commercial Bank performs all kinds of banking functions such as accepting deposits, advancing loans, credit creation & agency functions. They generally advance short term loans to their customers, in some cases they may give medium term loans also Industrial Banks : Ordinarily , the industrial banks perform three main functions : Firstly , Acceptance of Long term deposits : Since the industrial bank give long term loans , they cannot accept short term deposits from the public . Secondly, Meeting the credit requirements of companies : Firstly the industries require to purchase land to erect buildings and purchase heavy machinery . Secondly the industries require short term loans to buy raw materials & to make payment of wages to workers . Thirdly it does some Other Functions - The industrial banks tender advice to big industrial firms regarding the sale & purchase of shares & debentures Agricultural Banks : As the commercial & the industrial Banks are not in a position to meet the credit requirements of agriculture , there arises the need for setting up special types of banks to finance agriculture. Firstly, the farmers require short term loans to buy seeds, fertilizers, ploughs and other inputs . Secondly, the farmers require long term loans to purchase land, to effect permanent improvements on the land to buy equipment & to provide for irrigation works . Foreign Exchange Banks : Their main functions is to make international payments through the purchase and sale of exchange bills . As is well known , the exporters of a country prefer to receive the payment for their exports in their own currency . Hence their arises the problem of

converting the currency of one country into the currency of another . The foreign exchange banks try to solve this problem . These banks specialize in financing foreign trade . Indigenous Banks : According to the Indian Enquiry Committee , “ Indigenous banker is a person or a firm which accepts deposits , transacts business in hundies and advances loans etc ”.

1.6 Banking Sector in India Central Bank : The Reserve Bank of India is the central Bank that is fully owned by the Government. It is governed by a central board (headed by a Governor) appointed by the Central Government. It issues guidelines for the functioning of all banks operating within the country. Public Sector Banks a. State Bank of India and its associate banks called the State Bank Group b. 20 nationalized banks c. Regional rural banks mainly sponsored by public sector banks Private Sector Banks a. b. c. d. e.

Old generation private banks New generation private banks Foreign banks operating in India Scheduled co-operative banks Non-scheduled banks

Co-operative Sector The co-operative sector is very much useful for rural people. The co-operative banking sector is divided into the following categories. a. State co-operative Banks b. Central co-operative banks c. Primary Agriculture Credit Societies Development Banks/Financial Institutions IFCI, IDBI , ICICI Bank , IIBI SCICI Ltd. NABARD Export-Import Bank of India National Housing Bank Small Industries Development Bank of India North Eastern Development Finance Corporation

2. Role of Banks A proper financial sector is of special importance for the economic growth of developing and underdeveloped countries. The commercial banking sector which forms one of the backbones of the financial sector should be well organized and efficient for the growth dynamics of a growing economy. No underdeveloped country can progress without first setting up a sound system of commercial banking. The importance of a sound system of commercial banking for a developing country may be depicted as follows : Capital Formation: The rate of saving is generally low in an underdeveloped economy due to the existence of deep-rooted poverty among the people . Even the potential savings of the country cannot be realized due to lack of adequate banking facilities in the country . To mobilize dormant savings and to make them available to the entrepreneurs for productive purposes , the development of a sound system of commercial banking is essential for a developing economy . Monetization : An underdeveloped economy is characterized by the existence of a large non monetized sector , particularly , in the backward and inaccessible areas of the country . The existence of this non monetized sector is a hindrance in the economic development of the country . The banks , by opening branches in rural and backward areas , can promote the process of monetization in the economy . Innovations : Innovations are an essential prerequisite for economic progress . These innovations are mostly financed by bank credit in the developed countries . But the entrepreneurs in underdeveloped countries cannot bring about these innovations for lack of bank credit in an adequate measure . The banks should , therefore , pay special attention to the financing of business innovations by providing adequate and cheap credit to entrepreneurs . Finance for Priority Sectors : The commercial banks in underdeveloped countries generally hesitate in extending financial accommodation to such sectors as agriculture and small scale industries , on account of the risks involved there in . They mostly extend credit to trade and commerce where the risk involved is far less .But for the development of these countries it is essential that the banks take risk in extending credit facilities to the priority sectors , such as agriculture and small scale industries . Provision for Medium and Long term Finance : The commercial banks in underdeveloped countries invariably give loans and advances for a short period of time . They generally hesitate to extend medium and long term loans to businessmen. As is well known , the new business need medium and long term loans for their proper establishment . The commercial banks should , therefore , change their policies in favor of granting medium and long term accommodation to business and industry . Cheap Money Policy : The commercial banks in an underdeveloped economy should follow cheap money policy to stimulate economic activity or to meet the threat of business recession. In

fact , cheap money policy is the only policy which can help promote the economic growth of an underdeveloped country . It is heartening to note that recently the commercial banks have reduced their lending interest rates considerably . Need for a Sound Banking System : A sound system of commercial banking is an essential prerequisite for the economic development of a backward country .

2.1 Role of Banks in Indian Economy In India , as in many developing countries , the commercial banking sector has been the dominant element in the country‟s financial system . The sector has performed the key functions of providing liquidity and payment services to the real sector and has accounted for the Bulk of the financial intermediation process . Besides institutionalizing savings , the banking sector has contributed to the process of economic development by serving as a major source of credit to households , government , business and to weaker sectors of the economy like village and small scale industries and agriculture. Over the years, over 30-40% of gross household savings , have been in the form of bank deposits and around 60% of the assets of all financial institutions accounted for by commercial banks. An important landmark in the development of banking sector in recent years has been the initiation if reforms following the recommendations of the first Narasimham Committee on Financial System. In reviewing the strengths and weaknesses of these banks , the Committee suggested several measures to transform the Indian banking sector from a highly regulated to a more market oriented system and to enable it to compete effectively in an increasingly globalised environment . Many of the recommendations of the Committee especially those pertaining to Interest rate , an institution of prudential regulation and transparent accounting norms were in line with banking policy reforms implemented by a host of developing countries since 1970‟s .

2.2 Role of Central Bank ( RBI ) The main objectives for the establishment of the Central Bank were as follows : To manage the monetary and credit system of the country. To stabilizes internal and external value of rupee For balanced and systematic development of banking in the country For the development of organized in the money market in the country . For proper arrangement of agriculture finance. For proper arrangement of Industrial Finance . To establish monetary relations with other countries of the world & international financial institutions. For proper management of public debts . For centralization of cash reserves of commercial banks .

To maintain balance between the demand and supply of currency .

2.3 Evolution of Indian Banking Prior to 1969 , all banks , except State Bank of India and its seven associate banks were privately owned /. However there was a perception among policy makers that under private ownership , too many rural and semi urban-areas remained un-served by banks , whereas the banking industry has to be developed to “touch the lives of millions”. Further as India became an increasing planned economy , policy makers felt that „It would be difficult to undertake credit planning unless the link control of industry and banks in the same (private) banks is snapped by the nationalization of banks‟ (Hazari Report , 1967) . These considerations led to the Nationalization Act of 1969 which caused 14 largest privately owned domestic banks to be nationalized. In 1980 under the same Act , the Government of India acquired ownership of 6 more private banks , bringing the total number of nationalized banks to 20 . Notwithstanding the positive role played by the banking sector since nationalization in institutionalizing savings and becoming a source of credit to the small borrower , the cumulative effect of excessive focus on quantitative achievement and social obligations took a toll on profitability and efficiency . Rates of return became low by international standards , the capital base was eroded, NPS‟s were on the rise, and customer service was below expectation . These conditions led to gradual liberalization of banking sector operations since the mid 1980‟s and culminated in the initiation of fundamental banking sector reforms of 1992 with the acceptance of key recommendations of the Narasimham Committee .

2.4 Narasimham Committee Banking Reforms Restructuring of the banking system : The committee recommended 4-tier structure of the banking system consisting of : (a) : Three of Four Large (international) banks . (b) : Eight to ten national banks with a network of branches throughout the country . (c) : Local works with operations confined to a specific region. (d) : Rural Banks with operations confined to rural areas and business confined to agricultural and allied activities . Enhancement of Capital Base of Bank : The committee recommended that the banks should be allowed to raise fresh capital from the public . Mutual Funds , profitable public sector units and employees can also subscribe to these issues . Deregulation of Interest Rates : The committee recommended deregulation of interest rate on loan so that they reflect the actual market conditions . The interest rate on government borrowings may also be gradually deregulated to bring it in line with market rates . However interest rate on bank deposits may continue to be regulated . The first step was taken in October 1994 , when rates were deregulated for advances more than 2 lakh . In April 1998, under new regulations interest on credit limits up to Rs 25,000 was

prescribed at 12% and for credit limit between Rs 25,000 and Rs 2 lakh , the rate was not to exceed 13.5% per annum . Abolition of Licensing : The committee proposed no further nationalization of banks . It proposed abolition of branch licensing. It said that the banks should be allowed to decide for themselves. The foreign banks, private banks should be allowed to open branches in the country Cut in SLR , CRR : The committee recommended bringing down the SLR of banks in a phased manner period of five years . It also recommended reducing of CRR from its present high level . Trends in Cash Reserve Ratio (CRR) and statutory liquidity ratio (SLR) 1991-92 to 1997-98 Year CRR (As % of NDTL*) 1991-2 15 1992-3 15 1993-4 14 1994-5 15 1995-6 14 April 1996 13 July 1996 12 October 1996 11.5 January 1997 10 October 1997 9.75 January 1998 10.5 April 1998 10 Note: *Net demand and time liabilities

Base SLR (as % of NDTL*) 38.5 37.75 34.75 33.75 31.5 31.5 31.5 31.5 31.5 25 25 25

Source : RBI , Annual Report, Various issues and RBI Credit Policy October 97, April 98 The committee favoured of putting on end to dual control over banks by RBI and Banking division. It suggested that RBI should be the primary agency for regulations . Supervisory functions over banks and financial institutions should be given to a new quasi autonomous body under RBI . The committee favoured scrapping of prior approval of Government or Securities Exchange Board of India for any issue in the market . The issuing company should be free to decide on the nature of the instrument , its terms and lending. Foreign banks should be subject to same requirements as applicable to Indian banks . They should be permitted to open offices in India as branches or as subsidiaries . Computerization of Bank Operations needs to be stepped up .

The committee also proposed that its directed credited programme should be phased out . The priority sector should be redefined to comprise small and marginal farmers , the tiny sector of the industry , village and cottage industries , small business and other weak sections . A special tribunal should be set up to speed up the process of recovery of overdue loans . An asset reconstruction fund should be set up to speed up the process of recovery of overdue loans.

2.5 Performance of Indian Banking Sector Post Reforms We now look into the different aspects of bank performance which have been targeted by the reforms. These are : 1. 2. 3. 4. 5. 6. 7.

Deposit mobilization Portfolio Choice Competition Profitability Efficiency Capital Adequacy NPA‟s

Deposit Mobilization : Estimates of trends in real deposit growth post reforms reveal that the rate of growth has fluctuated, slackening between 1994-5 and 1995-6 but picking up during 1996-7 . Growth rates of key banking Variables (1981) Item

1980-81 to 1989-90 9.8

1990-91 to 1995-96 6.8

1993-94 to 1994-1995 10.7

1994-95 to 1995-96 4.1

1995-96 to 1996-97 6.3

Aggregate Deposits Time 10.2 6.5 8.1 5.8 7.2 deposits Bank Credit 8.7 4.2 -1.6 9.3 -1.9 Investments 10.5 10.3 22.9 4.3 9.6 in Govt Securities Note : Compound annual growth rates. All estimates are in real terms . Given in % forms . Sources : RBI annual report 1996-97 and RBI Bulletin Different issues In a nutshell , the present banking scenario with respect to deposits and advances can be observed from the following table :

Year 199900 200001 200102 200203 200304 200405 200506 200607

% Increase in Deposits 19.23

% Increase in Advances 31.5

% Growth in GDP 9.59

17.2

30.93

7.53

14.26

23.6

7.8

13.02

15.12

10.94

16.47

16.93

13.6

39.96

30.99

13.88

9.11

32.3

15.15

23.88

30.93

14.47

Source : RBI Trend and progress of banking in India various issues Bank credit consists of food and non food credit and bank investments comprise of investment in Government securities, bonds, debentures , shares issued by public sector undertakings and private corporate sector and commercial paper . The rate of growth on non food credit between 1995-96 and 1996-07 was a negative 0.7 compared to a growth rate off 11.6% between 1994-95 and 1995-96 . A comparison of growth Rate on investment in government securities in real terms over the pre-reform and post-reform years does not reveal substantial differences . Competition : With the entry of new private banks , the market shares of public sector banks have declined by close to 4% points from around 90% in 1991-92 to around 85% in 1995-96 . This kind of competition has led to adoption of newer banking practices like ATM , Online transactions and others to fit in the global competitive market . Profitability : Estimates for 1996-97 show public sector banks turning a net profit of 30.95 billion wiping out the loss of 3.71 billion in 1995-96 . Efficiency : An increase in competitive pressures is expected to improve efficiency levels. However in this regard , there has been marginal improvement except the state bank group and old domestic private banks .

Capital Adequacy : In 1996-97 , out of the 27 public sector banks, 25 have attained the BIS norm of an 8% risk waited capital to asset ratio . Non performing Assets : In 1993-94 , the average percentage of NPA‟s to total advances for 27 public sector banks was 21.89 which declined to 9.8% of total advances in 1996-97 .

3 Methodology In this section, the objective of the paper will be to check whether there exists some kind of relation between the total deposits of all banks with respect to the GDP. We then look at the state wise Credit Deposit Ratio over the last 4 years and observe which states have higher ratios which in turn could possibly be because of the progressing industrial and economic growth of the states . In another observation we compare the interest lending rates v/s the GDP growth rate . We also compare the Flow of credit to Agricultural Sector v/s Growth of Agriculture Sector. We conclude the analysis by an overview and analysis of the sectorial deployment of gross bank credit over the last two financial years.

3.1 Data Analysis The logic behind this analysis is that, the service sector of the economy has been growing profoundly over the years. The financial sector is an important subsector of the service sector. So it can be assumed that if there is an improvement in the performance of the financial sector, it will have necessary spill over effects on the service sector and hence the GDP. GDP FC (Real) in Rs Crore at 1993-94 prices.

Years 1990-91 1991-92 1992-93 1993-94 1994-95 1995-96 1996-97 1997-98 1998-99 1999-00 2000-01 2001-02 2002-03 2003-04 2004-05

Financial, Insurance,Real Estate and business Services 66990 281156 75027 294643 79430 310411 90084 334216 95085 357890 102847 395312 109995 423774 122784 465228 131892 504307 145863 555059 150910 586190 157733 625090 171463 674572 183718 735696 196820 801468

Source : Handbook of Indian Statistics 1200000 1000000 800000 600000 400000 200000 0

Services

Financial, Insurance,Real Estate and business services

Deposits-Advances : GDP Relationship Here, GDP is taken as the dependent variable which depends on the total deposits and total advances given by all banks together in the Indian economy from 1998-2007. The regression equation is framed as Z= α+βx+γy, where Z: GDP, x: total deposits, y: total advances Deposits-Advances : GDP Relationship Year 199899 199900 200001 200102 200203 200304 200405 200506 200607

Total Deposits 1425677.9

Total Advances 561184.32

GDP 18,942.53

1699814.81

737956.45

20,759.16

1992193.04

966200.14

22,321.53

2276377.74

1194221.3

24,061.98

2572681.84

1374770.6

26,695.47

2996489.72

1607526.5

30,326.62

4193840.49

2105622.45

34,536.37

4575872.49

2785759.89

39,769.60

5049019.24

3647284.56

45,525.95

Source : Trend and Progress of Banking in India - Different issues, IMF.org

SUMMARY OUTPUT Regression Statistics Multiple R 0.997954 R Square 0.995912 Adjusted R Square 0.994549 Standard Error 672.8468 Observatio ns 9

ANOVA df Regression

2

Residual

6

Total

8 Coefficien ts

SS 6.62E+0 8 271633 7 6.64E+0 8

Intercept

11965.14

X Variable 1

0.002786

Standar d Error 819.152 2 0.00079 1

X Variable 2

0.005383

0.00103

MS 3.31E+0 8 452722. 8

F 730.832 9

t Stat 14.6067 3 3.52135 4 5.22654

P-value 6.46E06 0.01249 8 0.00196 4

Significanc eF 6.83E-08

Lower 95% 9960.745 0.00085 0.002863

Upper 95% 13969.5 3 0.00472 2 0.00790 4

Lower 95.0% 9960.74 5 0.00085 0.00286 3

Upper 95.0% 13969.5 3 0.00472 2 0.00790 4

The analysis shows up a P-Stat value of 0.002 for Variable 2 which in this case is the total advances by banks . Therefore as per the hypothesis , the dependent variable GDP depends positively with the independent variable – Total Advances . However the values for deposits are not significant as t <3 and P stat value is greater than 0.005 .

120 100 80 60 40 20 0

Haryana Himachal… Jammu and… Punjab Rajasthan Chandigarh Delhi Arunachal… Assam Manipur Meghalaya Nagaland Tripura Bihar Jharkhand Orissa Sikkim West Bengal Andaman… Chhatisgarh Madhya… Uttar Pradesh Uttaranchal Goa Gujrat Maharashtra Dadra and… Andhra… Karnataka Kerala Tamil Nadu Lakhshadeep Pondicherry

Avg Credit-Deposit Ratio 2003-2007

180 160 140 120 100 80 60 40 20 0

2003-04 2004-05 2005-06 2006-07

Source : Economic Survey of India 2008

A state wise comparison of the credits and deposits in India . It shows a few states having a high CDR ratio . We assume that this higher CDR is because of the progressing industrial growth in those states which otherwise can also be correlated to the economic growth of these states .

2005-06 : State GDP v/s State Credit Deposit Ratio Maharashtra Uttar Pradesh Andhra Pradesh Tamil Nadu West Bengal Gujarat Karnataka Kerala Rajasthan Madhya Pradesh Punjab Delhi Haryana Bihar Orissa Jharkhand Assam Chattisgarh Jammu and Kashmir Himachal Pradesh Goa Chandigarh Union Territory Meghalaya Tripura Pondicherry Union Territory Manipur Nagaland Arunachal Pradesh Sikkim Andaman and Nicobar Islands Territory Dadra and Nagar Haveli Territory Lakshadweep Territory

State GDP 2005Credit Deposit 06 Ratio 4,324,130 75.9 2,737,850 42.2 2,691,730 83.3 2,462,660 105.4 2,360,440 56.8 2,166,510 60.9 1,750,930 80.5 1,327,390 57.5 1,241,990 76.6 1,185,860 61.2 1,047,050 49.7 1,053,850 62.5 1,006,760 63.2 796,820 31.4 714,280 74.7 629,500 30.6 575,970 41.9 519,210 49.9 242,650 50.9 254,350 50.9 124,000 30.3 98,720 97 70,520 85.7 66,010 29 64,570 43.9 64,380 42.6 53,460 23.2 22,620 30 20,400 29.3

Data Source : Economic Survey of India 2008

15,620 7,001 1,909

43.8 110.8 23.7

SUMMARY OUTPUT Regression Statistics Multiple R R Square Adjusted R Square Standard Error Observations

0.374318148 0.140114076 0.111451212 1008953.434 32

ANOVA df Regression Residual Total

SS MS F Significance F 1 4.98E+12 4.98E+12 4.888349 0.034804 30 3.05E+13 1.02E+12 31 3.55E+13

Coefficients Standard Error t Stat P-value Lower 95% Upper 95%Lower 95.0% Upper 95.0% -9680.041547 460124.9 -0.02104 0.983355 -949381 930020.4 -949381 930020.4 16715.25724 7560.177 2.210961 0.034804 1275.316 32155.2 1275.316 32155.2

Intercept X Variable 1

As per the analysis , the t-stat value is less than 3 , therefore the dependent variable (GDP) depends positively and significantly with the independent variable – Credit Deposit Ratio .

Comparison of the Interest Rates on Deposits & Bank Lending rates : 25 20 15 INDIA lending rates 10

India Deposit rates

5 0 1985

1990

1995

2000

Bank lending rates v/s GDP Growth Rate YEAR 1987 1988 1989 1990 1991 1992

% Growth in GDP

7.359732163 -2.500134416 4.53595456 -12.33135776 -0.766594761

INDIA lending rates 16.5 16.5 16.5 16.5 16.5 16.5

2005

2010

1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007

-4.066628061 19 11.0989261 19 11.19853671 15 0.761056423 16.5 10.15718025 14.5 -1.137626012 14 4.998950927 13 1.845055318 12 0.563327469 11.5 3.007238444 11.5 14.01362491 10.75 14.97676033 10.25 15.16242242 10.25 10.3708774 10.25 23.49558366 11 Source : RBI Annual Report 2008

SUMMARY OUTPUT Regression Statistics Multiple R 0.525583 R Square 0.598783 Adjusted R Square 0.577666 Standard Error 111.3628 Observations 20 ANOVA df Regression Residual Total

Intercept X Variable 1

SS MS F Significance F 1 363.5838 363.5838 6.870023 0.017314 18 952.6183 52.92324 19 1316.202

Coefficients Standard Error t Stat P-value Lower 95% Upper 95%Lower 95.0% Upper 95.0% 26.30944 8.052966 3.267049 0.004281 9.390781 43.22809 9.390781 43.22809 -1.47134 0.561349 -2.62107 0.017314 -2.65069 -0.29199 -2.65069 -0.29199

A very significant causation was found between GDP and lending interest rates from the above data . It can be inferred that : If rate of interest on advances increases, then the GDP of the country also increases . The value of T is very significant with a value of -2.621.

2040 2030 2020 2010 India Deposit rates 2000

INDIA lending rates GDP Growth Rate

1990

YEAR 1980 1970 1960 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21

Source : Trend and Progress of Banking in India , RBI.org.in

Source : Economic Survey of India 2008 Over the past 2 years , the CDR ratio has come down. Compared to 2005-06 , the 2007-08 CDR is very less. There is a decreasing tendency of CDR as we go towards the end of the financial year .

Flow of credit to Agricultural Sector v/s Growth of Agriculture Sector Year 2001-02 2002-03 2003-04 2004-05 2005-06 2006-07

Total Credit 59322 69,560 86,981 1,25,309 1,36,899 1,58,076

% change in total credit 17.26 25.04 44.06 9.24 15.49

% Growth in Production 6.084396467 8.254963427 1.544401544 4.27756654 0.546946217

SUMMARY OUTPUT Regression Statistics Multiple R 0.189136 R Square 0.035772 Adjusted R Square -0.28564 Standard Error 3.602555 Observation s 5 ANOVA df Regression Residual

1 3

Total

4

SS 1.44447 5 38.9352 40.3796 8

Coefficien ts

Standar d Error

t Stat

P-value

5.134431

3.38396 3

1.51728 4

0.22647 6

-0.04468

0.13392 8

0.33361

0.76062 8

Intercept

X Variable 1

MS 1.44447 5 12.9784

F 0.11129 8

Significanc eF 0.760628

Lower 95%

Upper 95%

-5.63485

15.9037 1

-0.4709

0.38153 9

Lower 90.0% 2.8292 6 0.3598 6

From the regression analysis and the value of R Square , we can see that there is a minute causation found between total credit given to agriculture sector and percentage growth of agriculture production .

Upper 90.0% 13.0981 3 0.27050 1

Sectorial Deployment of Gross Bank Credit Items 2005-06 2006-07 Gross Bank Credit 38 27.6 Public Food Procurement Credit 1 14.3 Gross Non-Food Bank Credit 39.6 27.9 (A) Priority Sectors 36.1 24 Agriculture and allied activities 39.9 32.4 Small Scale Industry 22.7 28.4 Housing 47.5 21.5 Other Priority Sectors 30 10.4 (B) Medium and large industries 31.5 25.2 (C ) Wholesale Trade 25.4 25.1 (D) Other Sectors 58.2 36.5 Housing 19.2 32.5 Consumer Durables 20.9 28.9 Real Estate Loans 97.1 69.8 Loans to individuals 27.4 13.7 Source : Reserve Bank of India Note : Data is provisional and accounts for 90% of bank credit of SCB's

The priority of giving credit in 2005-06 was more towards the Non food bank , Housing , Real Estate , and agriculture and allied activities sector . However in 2006-07 , more priority credit was given to Real Estate , Housing , agriculture and allied activities . Noticeable change was the gap of the credit given to whole sale trade and medium and large industries was reduced from 2005-06 to 2006-07 . Also there was a significant decrease in the loans given to individuals . But public food procurement credit increased drastically from 1 to 14%.

3.2 Remarks As per the data analysis , GDP depends positively with the Total Advances A few Indian states have a high CDR ratio , this could be because of the progressing industrial growth in those states which otherwise can also be correlated to the economic growth of these states GDP depends positively and significantly with the Credit Deposit Ratio . A very significant causation was found between GDP and lending interest rates from the above data . It can be inferred that If rate of interest on advances increases, then the GDP of the country also increases . The priority of giving credit over the last three years has been more towards the Non food bank , Housing , Real Estate , and agriculture and allied activities sector . There was a significant decrease in the loans given to individuals . But public food procurement credit increased drastically. The current global financial crisis is now the staple of front page news. Banks around the world, including those in India, are in the forefront of managing the challenge of crisis resolution. Since it is so topical, I would like to take this opportunity to share my perspective on the current global turmoil, its impact on India, the outlook for the Indian economy and the challenges that lie ahead for the Indian banking system, in particular. The Indian banking system is not directly exposed to the sub-prime mortgage assets. It has very limited indirect exposure to the US mortgage market, or to the failed institutions or stressed assets. Indian banks, both in the public sector and in the private sector, are financially sound, well capitalised and well regulated. The average capital to risk-weighted assets ratio (CRAR) for the Indian banking system, as at end-March 2008, was 12.6 per cent, as against the regulatory minimum of nine per cent and the Basel norm of eight per cent. Even so, India is experiencing the knock-on effects of the global crisis, through the monetary, financial and real channels – all of which are coming on top of the already expected cyclical moderation in growth. Our financial markets – equity market, money market, forex market and credit market – have all come under pressure mainly because of what we have begun to call 'the substitution effect' of : (i) drying up of overseas financing for Indian banks and Indian corporates; (ii) constraints in raising funds in a bearish domestic capital market; and (iii) decline in the internal accruals of the corporates. All these factors added to the pressure on the domestic credit market. Simultaneously, the reversal of capital flows, caused by the global de-leveraging process, has put pressure on our forex market. The sharp fluctuation in the overnight money market rates in October 2008 and the depreciation of the rupee reflected the combined impact of the global credit crunch and the de-leveraging process underway.

3.3 The Challenges Ahead Let me now turn to the major challenges facing the banking system in the country, particularly in the wake of the global financial crisis. The First Challenge: Maintaining the Credit Flow There was a noticeable decline in the credit demand in the month of November 2008 but it is not yet clear if it was a one off episode or it reflects a trend. If it is indicative of slowing economic activity, it would be a major challenge for the banks to ensure healthy flow of credit to the productive sectors of the economy. As you know, economic growth, even in normal times, requires efficient financial intermediation. An economic downturn, therefore, requires even more efficient financial intermediation – and this is a major challenge that the banking community has to address. The Second Challenge: How to Reform Financial Sector Regulation? Several issues have come to the fore. I will mention just a few. How can complex derivative products, which transmitted risks across the system, be made more transparent? What are the financial stability implications of structured products like credit derivatives? Are exchange traded derivatives better than over-the-counter (OTC) derivatives? How do we eliminate the drawbacks of the 'originate-to- distribute' model? Is universal banking, the model that the United States has now turned to, appropriate? Can we apply the same regulatory regime for both wholesale and retail banks? The Third Challenge: Effective Implementation of Basel II Framework As you are aware, a part of the Indian banking system has already migrated to the Basel II Framework effective March 31, 2008 and the remaining commercial banks are slated to do so by March 31, 2009. However, having regard to the state of preparedness of the system, we have, for the present, adopted only the simpler approaches available under the Framework. The RBI is yet to announced the timeframe for adoption of the Advanced Approaches in the Indian banking system but the migration to these Approaches is the eventual goal – for which the banking system will need to start its preparations in all earnestness.

3.4 Conclusion Going forward, developments in the real economy, financial markets and global commodity prices point to a period of moderation in growth with declining inflation. What is heartening though is that the fundamentals of our economy continue to be strong. Once calm and confidence are restored in the global markets, economic activity in India will recover sharply. But a period of painful adjustment is inevitable. It is our collective challenge – for you, the bankers, and for us at the RBI – to respond to this extraordinary situation effectively and return India to its path of growth and poverty reduction.

References Trend and Progress of Banking in India ( Different issues from 1990 – 2007) Annual Report RBI ( Different issues ) Economic Survey of India 2008 Handbook of Indian statistics www.IMF.org www.RBI.org.in www.wikipedia.org www.Google.com

Acknowledgement I am grateful to Prof. Tamal Datta Chaudhuri for giving me the project idea and guided me all along with his suggestions. The Role of Banks is very apt in the current financial scenario . I also extend my gratitude to Dr. Basudeb Sen for his expert consultation and for guiding me in analyzing the data for this project . I am also thankful to the institute for technical support and for providing the necessary software‟s which helped me in data analysis. Lastly I would also like to thank RBI Calcutta for providing me the necessary data for the project, some of which was otherwise not available online .