ISSN (Print) - 0012-9976 | ISSN (Online) - 2349-8846

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Some Evidence for India

Non-interest Income and Stability of Commercial Banks

The impact of the share of non-interest income on the risk of banks in India for the period 1993–2018 is examined, employing coefficients of variation, and linear and quantile regression techniques. The higher share of non-interest income leads to diversification benefits and reduces the risk of banks. The share of non-interest income has fallen and more banks have become unstable in the last decade. For the nationalised and foreign banks, the increase in the proportion of non-interest income has led to greater stability. However, for some of the private banks, this relation is not linear.

 

As a part of the structural reforms in the economy in 1992, the Government of India initiated a series of reforms in the Indian banking sector. These measures provided greater opportunities to banks to expand and diversify their business in different dimensions. Banks continue to be a critical part of the financial system as most household savings are channelled through the banking system. Bank credit extended grew to $1.3 trillion by 2018. As in other countries, after deregulation, Indian banks have diversified from traditional activities in search of higher profits. As a result, the income from non-interest income sources, such as commission, brokerage, and trading, became a significant part of bank profits (Mohan 2005).

The process of deregulation allowed for the liberal entry of foreign banks and the establishment of private banks. This increased competition among banks. The reforms brought in micro-prudential measures, such as capital adequacy norms, in line with global practices (Pennathur et al 2012). As per Basel I norms, different types of assets attract different risk weights. While the investment portfolio of banks attracted 0% risk weight since they invested in government securities, loans to the commercial sector attracted 100% risk weight in the capital to risk weighted assets ratio calculation. This made commercial lending unfavourable for banks. Besides, priority sector lending also squeezed banks to some extent as the lending rates to certain sections of the society had to be on non-commercial lines.

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Updated On : 21st Apr, 2021

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