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

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Indian Banks' Diminishing Appetite for Government Securities: A Change of Diet?

Indian banks' holdings of government securities - measured in rupees - have fallen for the first time in almost 40 years and are now close to the statutory minimum. Such holdings remain, however, large and draw attention to their risk as interest rates are increasing. This paper reviews the reasons why such holdings are so large and measures their interest rate risk using duration/convexity and value-at-risk methods. The first key finding is that, at end-March 2004, some public sector and old private banks were vulnerable to a reversal of the interest rate cycle, while foreign and new private banks had built adequate defences. The second key finding is that recent changes in regulation such as the move to Basel I and the road map to Basel II are important as they make Indian banks' capital more sensitive to interest rate risk.

Hedge Funds

Owing to the substantial risks involved, hedge funds are normally open only to professional, institutional or otherwise accredited investors. This paper outlines the structure of hedge funds, the investment strategies pursued and possible returns.

Corrective Steps towards Sound Banking

The Indian economy is facing some serious macroeconomic problems due to rapidly rising inflation and interest rates, a growing trade deficit and an uncertain global environment, which involves risks of sudden adjustments in the currency value and corrections in financial markets. In this situation, questions about the banking sector's ability to respond effectively to the unwinding of macroeconomic imbalances remain. This paper suggests some necessary short- and medium-term corrective measures to stabilise and improve the soundness of the Indian banking sector to face these challenges.

Commodity Derivatives Market in India

The modern commodity market finds its origin in the trading of agricultural products. This article traces the evolution and development of the commodity derivatives market in India. The article then goes on to outline its infrastructure and how it is regulated.

Basel II and Bank Lending Behaviour

The new Basel accord is slated to come into effect in India around 2007 raising the question of how the revised standards will influence bank behaviour. Using a simple theoretical model, it is shown that the revised accord will result in asymmetric differences in the efficacy of monetary policy in influencing bank lending. This will, however, depend on a number of factors, including whether banks are constrained by the risk-based capital standards, the credit quality of bank assets and the relative liquidity of banks' balance sheets. The basic model is empirically explored using data on Indian commercial banks for the period 1996-2004. The analysis indicates that the effect of a contractionary monetary policy will be significantly mitigated provided the proportion of unconstrained to constrained banks in the system is significantly high.

A Review of Bank Lending to Priority and Retail Sectors

The surge in bank credit in the last couple of years has been an encouraging phenomenon in Indiaâ??s banking sector. This reflects as much the turnaround in the economy as the improved balance sheets of the banks themselves. However, though overall credit growth has been of a high order, the expansion of agricultural credit and credit to small-scale industries sector has not kept pace with it. Retail credit, which is growing from a very low base, has expanded rapidly during this period. While consumption-led growth can help improve the growth rates in the economy, it would also result in increasing risks.

Life Insurance and the Macroeconomy

It has been observed that there is a significant relationship between the demand for life insurance and various macroeconomic variables. High growth of GDP induces an economic effect through higher per capita and disposable income and savings, which in turn create a favourable market demand for life insurance. On the other hand, life insurance also provides support to the capital market and savings data pertaining to Indian life insurance and macroeconomic variables broadly indicate a close relationship and interdependence between macroeconomic variables and life insurance demand.

Universal Banking: Solution for India's Financial Challenges?

Faced with pressures of international financial liberalisation, it is natural that Indian policy-makers want intermediaries to consolidate and improve their competitive position in both domestic and global marketplaces. Acquisition of a "universal banking" structure could be perceived as a strategic reaction of certain players to these changed circumstances. In an emerging economy like India where volatility is large, emergence of universal banks can contribute to faster economic growth as it assists in strengthening the alliance between companies and banks. A movement into universality is likely to promote consolidation in a healthy manner and hence should be encouraged.

Is the Role of Banks as Financial Intermediaries Decreasing?

The capital structure of Indian corporates reflects a churning, with a preference for internal financing over external financing. This behavioural pattern is the essence of the pecking order theory. In this context, is the role of banks as financial intermediaries decreasing? This exploratory article throws up lots of questions and provides a few answers.

Financial Liberalisation in India

The Indian experience with reform in the financial sector indicates that, inter alia, there are three important outcomes of such liberalisation. First, there is increased financial fragility, which the "irrational boom" in India's stock market epitomises. Second, there is a deflationary macroeconomic stance, which adversely affects public capital formation and the objectives of promoting employment and reducing poverty. Finally, there is a credit squeeze for the commodity producing sectors and a decline in credit delivery to rural India and small-scale industry. The belief that the financial deepening that results from liberalisation would in myriad ways neutralise these effects has not been realised.

Internal Credit Rating Practices of Indian Banks

The overarching goal of the second Basel accord is aligning the capital requirements of banks with risk sensitivity. The accord emphasises the quantification of capital requirements on the basis of internal rating models. The internal credit rating models of banks are expected to produce the probability of default and loss given default to estimate the capital requirements of credit risk. This paper presents an analysis of the current status of internal credit rating practices of Indian banks. The survey reveals that the components of internal rating systems, their architecture, and operation differ substantially across banks. The range of grades and risks associated with each grade vary across banks analysed. This implies that lending decisions may vary across banks. There are differences among the rating systems of various banks. This paper presents a set of actions to improve the quality of internal rating models of Indian banks.

On Liberalising Foreign Institutional Investments

This paper critiques the approach and recommendations of the 2004 government of India expert group on foreign institutional investment flows. The groupâ??s approach raise several important analytical and policy issues. The most crucial of these relate to effects of FII flows on (a) aggregate and sectoral investment; (b) behaviour of financial, including foreign currency, markets with special reference to their volatility; and (c) efficacy of fiscal and monetary instruments in attaining the objectives of macrostabilisation and growth. The article examines the macroeconomic impact of FII flows in the light of the Indian experience, and draws some policy conclusions regarding the role of such flows. It also addresses the issue of volatility in the Indian context. It finds there is no coherent macroeconomic model behind the expert groupsâ??s analysis and recommendations; no appraisal either of the optimal scale of capital inflows or the relative merit of FII vis-Ã -vis other categories of capital receipts at the current juncture of the economy; and no examination of monetary/fiscal problems associated with FII or of the quantitative impact of such flows on investment and other macro variables.

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