COMMERCIAL BANKS AND INDUSTRIAL

FINANCE – EVOLVING ROLE

INTRODUCTION In a developing country like India

financial institutions play an important role in promoting industrial sector.

This topic outlines the importance of banking sector in :

financing, impacts of banking sector reforms

on industrial growth, role played by banks in micro

financing in India.

BANKING SECTOR IN INDIAThough there are many financial

intermediaries banking sector in India has been contributing to a major portion of total credit lending to various sectors and in resource mobilization it has been playing a main role which is because of cumulative effects.

CUMULATIVE EFFECTS Assured rate of return on assets of

depositors in banks. Easy, costless access to services through

the large branch net work of banks. Virtually zero risk on the investments in

banks unlike other non banking sectors which pose greater risks.

GOI and RBI policies supported the cause of banks through their policies like, Interest rate ceiling on deposits with NBFC & Ceiling on quantum deposits in these companies.

BANKING SYSTEMThe banking system structure in India can

be branched and sub branched into various types. As Public, Private ,Regional Rural Banks , Cooperative Banks and Foreign Banks.

Reserve bank plays a crucial role in controlling the functioning of these banks through its policies in other words it is the central bank of India.

EVOLUTION OF BANKING IN INDIA

Traditionally banking operations in the country have been overwhelmingly dominated by scheduled commercial banks. The activities of these banks are regulated by RBI.

In 1955 GOI took over Imperial bank of India and reconstituted it as SBI.

In 1969 nationalization act was passed under which 14 banks were nationalized each with a minimum of 50 crore deposits. The main objectives for nationalization were to mobilize savings and channelize them for productive purposes.

CONT--- By 1980, six more banks were

nationalized each with at least 200 crore deposits.

But the situation by early 1990s, many public sector banks turned unprofitable and under- capitalized due to accumulation of non performing assets and earning low rates of return and capital inadequacy.

ROLE OF BANKS IN SHAPING INDIA: The "privileged role" of the banks is a result of

their unique features. Banks provide facilities to: mobilize, allocate saving of the country successfully

and productively, and to facilitate day to day transactions

through their large branch network spread all over the country.

ECONOMIES OF SCOPE The economies of scope between

deposit taking and lending give banks an information advantage over finance companies and others.

The structure and working of the banking system are integral to country's financial stability and economic growth.

LIABILITIES AND ASSETS OF BANK: Deposits constitute the major source of

funds for banks which constitute up to75%-80% of total bank liabilities in India along with borrowings from other banks and RBI.

Assets of banks include:1. cash in hand and2. balance with the RBI3. investments in government and other

approved securities and bank credit

BANKING SECTOR REFORMS

In 1991, Narasimham Committee setup by GOI recommended structural reforms and liberalization programme in the banking sector among them the following have been implemented by the government:

Deregulation of entry of new private sector banks both domestic as well as foreign to increase the allocation efficiency of the system

LIBERALIZATION OF BRANCH LICENSING POLICY Liberalization of branch licensing policy

allowing banks more freedom to plan branch expansion in response to market needs for increasing competition among public sector banks.

Phase wise deregulation of interest rates both on deposits and advances under which banks were freed to set interest rates on all term deposits up to 1year and on all advances greater than 2lakhs.

CAPITAL ADEQUACY NORMS Introduction of capital adequacy norm

capital to risky asset ratio of not less than 8% inline with the norms set by Bank for International Settlement (BIS).Institution of transparent prudential and income recognition norms to obtain true picture of financial situation of banks.

Allowing public sector banks to access capital market to raise equity to meet the additional capital needs. Gradual reduction of CRR and SLR to increase profitability of this sector.

IMPACTS OF BANKING REFORMS

Reforms have encompassed banks, stock markets, GOVT securities, institutional development. The period of reforms has witnessed the emergence of universal banking.

Reforms have had a positive impact on the working of commercial banks as reflected in their:

cleaner balance sheets, reduction in NPA, and increase in operating profit. The real interest rates increased with banks

investing more in GOVT under prudential norms there by increasing the demand for bank credit.

PRIVATE SECTOR BANKS

Prior to reforms the private sector banking was substantial when compared to public sector with the policies of GOVT and other risk aspects. Liberalization and deregulation of banking system opened the gates for new private firms to enter and old ones to rebuild.

Private sector banks have been showing positive profits on an average even though they have not received any incentives as the public sector banks gained from GOVT.

The growth rate in deposits in private sector banks has surpassed public sector banks in spite of this public sector banks still possess more than 90% of total deposits in this sector.

PRIVATE SECTOR BANKS Similarly in accumulation of NPA and

overall profitability private sector has been performing well than public sector.

In 2009 private sector banks managed to provide 20 %of total credit lended to industrial sector from a minimum contribution of about 3% in 1996.

With the increasing profitability and liberalization in the banking sector foreign private investors have been showing keen interest in India.

EQUITY FINANCE Old, large, profitable, low-risk firms (so-called

"high- quality" firms) tend to be more internally financed than firms that are new, small, unprofitable, and of high risk (so-called "low-quality" firms).

Further, the dependence of the High Quality Firms on Commercial Paper and foreign borrowings is greater than that of the Low Quality Firms.

On the other hand, the Low Quality Firms tend to borrow more heavily from domestic banks and financial institutions.

DIVERSIFICATION OF FINANCING SOURCES Over all, equity finance has become one of

the most important external financing sources during 1990-2001.

New, high-risk firms have also increased equity financing during 1990-2001, although their share capital in terms of total liabilities has remained smaller than old, low-risk firms.

This suggests that during the reform period, these low-quality firms have gained access to the equity market, helping them to diversify their financing sources.

BANKING SERVICES The indicative list of banking services includes

services relating to : Deposit Accounts (cheque book facility, issue of

pass book / statement, ATM Card, Debit Card, stop payment, balance enquiry, account closure, signature verification);

Loan Accounts (no dues certificate); Remittance facilities (Demand Draft – issue/ cancellation/ revalidation, Payment Order - issue/ cancellation/ revalidation/ duplicate, Telegraphic Transfer - issue/ cancellation/ duplicate,

Electronic Clearing Service (ECS), National Electronic Fund Transfer (NEFT) / Electronic Fund Transfer (EFT); Collection Facilities (collection of local /outstation cheques, cheque return- outward).

FINANCIAL INCLUSION Financial inclusion is not based on the principle of equity

alone – access to affordable banking services is required for inclusive growth with stability.

Achieving financial inclusion in a country like India with a large and diverse population with significant segments in rural and unorganized sectors requires a high level of penetration by the formal financial system.

Even in areas that are well covered by banks, there are sections of society excluded from the banking system.

Political and social stability also drive financial inclusion. In the recent period, in countries like India, government

has been encouraging opening of bank accounts by providing government benefits through such accounts.

FINANCIAL INCLUSION Financial inclusion is also not just micro

finance. Financial inclusion represents reliable access to affordable savings, loans, remittances and insurance services.

We in India believe that financial inclusion primarily implies access to a bank account backed by deposit insurance, access to affordable credit and the payments system.

SELF HELP GROUPS An important regulatory dispensation that

facilitated financial inclusion was given in the early 90s, when banks were allowed to open savings accounts for Self Help Groups (SHGs), which were neither registered nor regulated.

An SHG is a group of 15 to 20 members from very low income families, usually women, which mobilizes savings from members and uses the pooled funds to give loans to those members who need them, with the interest rates on deposits and loans being determined entirely by members.

CONT--- National Bank for Agriculture and Rural

Development (NABARD) launched the SHG–Bank Linkage Program in 1992 to forge the synergies between formal financial system and informal sectors.

Under this programme, banks provide loans to the SHGs against group guarantee and the quantum of loan could be several times the deposits placed by such SHGs with the banks.

CONT------ The recovery rates of such loans have been

good and banks have found that the transaction cost of reaching the poor through SHGs is considerably lower as such cost is borne by the SHG rather than the bank.

Interest earned from group members is retained in the group. The penetration achieved through SHGs has been very significant.

As per NABARD’s report on status of microfinance (2008-09), about 86 million poor households are covered under the SHG-Bank Linkage program with over 6.1 million saving-linked SHGs and 4.2 million credit-linked SHGs as on March 31, 2009.

MANDATED PRIORITY SECTOR LENDING

Priority sectors broadly include agriculture and allied activities, micro and small enterprises, education, housing and micro-credit.

All domestic commercial banks are required to allocate 40 per cent of their lending to the priority sectors.

For foreign banks, the requirement is 32 per cent and export credit is also included in their case.

Credit extended by banks to SHGs, micro finance institutions, to NBFCs for on-lending to priority sector, and to regional rural banks for agriculture and allied activities have been included in the definition of priority sector.

THANX