Role of Banks in Indian Economy

Macroeconomics Research Paper

Prepared by : Sourabh Kumar Saha
PGDM : 2008-2010
Calcutta Business School , West Bengal , India
Email : souravsaha86@gmail.com

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 Page
1. Introduction 3
1.1. Motivation 3
1.2. Hypothesis 4
1.3. What is a Bank 4
1.4 Functions of a Bank 4
1.5. Types of Banks 6
1.6. Banking Sector in India 7
2.0 Role of Banks 8
2.1. Role of Banks in Indian Economy 9
2.2. Role of Central Bank (RBI) 9
2.3. Evolution of Indian Banking 10
2.4. Narasimham Committee Banking Reforms 10
2.5. Performance of Indian Banking Sector Post Reforms 12
3.0. Methodology 15
3.1. Data Analysis 15
3.2. Remarks 25
3.3. The challenges Ahead 26
3.4. Conclusion 26
References 27
Acknowledgement 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. Accepting Deposits from public/others (Deposits)

2. Lending money to public (Loans)
3. Transferring money from one place to another (Remittances)
4. Credit Creation
5. Acting as trustees
6. Keeping valuables in safe custody
7. 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 Credit Cards
o Personal Loans
o Home and Car Loans
o Mutual Funds
o Business Loans
o Safe Deposit Boxes
o Debit Cards
o Trust Services
o 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. Old generation private banks

b. New generation private banks
c. Foreign banks operating in India
d. Scheduled co-operative banks
e. 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*) Base SLR (as % of NDTL*)

1991-2 15 38.5
1992-3 15 37.75
1993-4 14 34.75
1994-5 15 33.75
1995-6 14 31.5
April 1996 13 31.5
July 1996 12 31.5
October 1996 11.5 31.5
January 1997 10 31.5
October 1997 9.75 25
January 1998 10.5 25
April 1998 10 25
Note: *Net demand and time liabilities

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. Deposit mobilization
2. Portfolio Choice
3. Competition
4. Profitability
5. Efficiency
6. Capital Adequacy
7. 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 1990-91 to 1993-94 to 1994-95 to 1995-96 to

1989-90 1995-96 1994-1995 1995-96 1996-97
Aggregate 9.8 6.8 10.7 4.1 6.3
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 % Increase in Deposits % Increase in Advances % Growth in GDP
1999- 19.23 31.5 9.59
00
2000- 17.2 30.93 7.53
01
2001- 14.26 23.6 7.8
02
2002- 13.02 15.12 10.94
03
2003- 16.47 16.93 13.6
04
2004- 39.96 30.99 13.88
05
2005- 9.11 32.3 15.15
06
2006- 23.88 30.93 14.47
07
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 Financial, Insurance,Real Estate and business Services
1990-91 66990 281156
1991-92 75027 294643
1992-93 79430 310411
1993-94 90084 334216
1994-95 95085 357890
1995-96 102847 395312
1996-97 109995 423774
1997-98 122784 465228
1998-99 131892 504307
1999-00 145863 555059
2000-01 150910 586190
2001-02 157733 625090
2002-03 171463 674572
2003-04 183718 735696
2004-05 196820 801468
Source : Handbook of Indian Statistics
1200000
1000000
800000 Services
600000
400000
200000
Financial,
0
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 Total Deposits Total Advances GDP

1998- 1425677.9 561184.32 18,942.53
99
1999- 1699814.81 737956.45 20,759.16
00
2000- 1992193.04 966200.14 22,321.53
01
2001- 2276377.74 1194221.3 24,061.98
02
2002- 2572681.84 1374770.6 26,695.47
03
2003- 2996489.72 1607526.5 30,326.62
04
2004- 4193840.49 2105622.45 34,536.37
05
2005- 4575872.49 2785759.89 39,769.60
06
2006- 5049019.24 3647284.56 45,525.95
07
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
Significanc
df SS MS F eF
6.62E+0 3.31E+0 730.832
Regression 2 8 8 9 6.83E-08
271633 452722.
Residual 6 7 8
6.64E+0
Total 8 8

Coefficien Standar Lower Upper Lower Upper

ts d Error t Stat P-value 95% 95% 95.0% 95.0%
819.152 14.6067 6.46E- 13969.5 9960.74 13969.5
Intercept 11965.14 2 3 06 9960.745 3 5 3
0.00079 3.52135 0.01249 0.00472 0.00472
X Variable 1 0.002786 1 4 8 0.00085 2 0.00085 2
0.00196 0.00790 0.00286 0.00790
X Variable 2 0.005383 0.00103 5.22654 4 0.002863 4 3 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 .
 Avg Credit-Deposit Ratio 2003-2007
120
100
80
60
40
20
0

Andaman…

Madhya…

Dadra and…
Arunachal…

Andhra…
Himachal…
Jammu and…

Bihar
Haryana

Manipur
Punjab

Gujrat
Sikkim
Chandigarh

Jharkhand
Tripura

Orissa

Maharashtra

Karnataka
Rajasthan

Delhi

Nagaland

Uttaranchal

Tamil Nadu
Goa

Lakhshadeep
Meghalaya

Chhatisgarh

Kerala

Pondicherry
Assam

Uttar Pradesh
West Bengal
180
160
140
120
100
80
60 2003-04
40
20 2004-05
0
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
State GDP 2005- Credit Deposit
06 Ratio
Maharashtra 4,324,130 75.9
Uttar Pradesh 2,737,850 42.2
Andhra Pradesh 2,691,730 83.3
Tamil Nadu 2,462,660 105.4
West Bengal 2,360,440 56.8
Gujarat 2,166,510 60.9
Karnataka 1,750,930 80.5
Kerala 1,327,390 57.5
Rajasthan 1,241,990 76.6
Madhya Pradesh 1,185,860 61.2
Punjab 1,047,050 49.7
Delhi 1,053,850 62.5
Haryana 1,006,760 63.2
Bihar 796,820 31.4
Orissa 714,280 74.7
Jharkhand 629,500 30.6
Assam 575,970 41.9
Chattisgarh 519,210 49.9
Jammu and Kashmir 242,650 50.9
Himachal Pradesh 254,350 50.9
Goa 124,000 30.3
Chandigarh Union Territory 98,720 97
Meghalaya 70,520 85.7
Tripura 66,010 29
Pondicherry Union Territory 64,570 43.9
Manipur 64,380 42.6
Nagaland 53,460 23.2
Arunachal Pradesh 22,620 30
Sikkim 20,400 29.3
Andaman and Nicobar Islands
Territory 15,620 43.8
Dadra and Nagar Haveli Territory 7,001 110.8
Lakshadweep Territory 1,909 23.7

Data Source : Economic Survey of India 2008

SUMMARY OUTPUT

Regression Statistics
Multiple R 0.374318148
R Square 0.140114076
Adjusted R Square 0.111451212
Standard Error 1008953.434
Observations 32

ANOVA
df SS MS F Significance F
Regression 1 4.98E+12 4.98E+12 4.888349 0.034804
Residual 30 3.05E+13 1.02E+12
Total 31 3.55E+13

Coefficients Standard Error t Stat P-value Lower 95% Upper 95%Lower 95.0%
Upper 95.0%
Intercept -9680.041547 460124.9 -0.02104 0.983355 -949381 930020.4 -949381 930020.4
X Variable 1 16715.25724 7560.177 2.210961 0.034804 1275.316 32155.2 1275.316 32155.2

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

0
1985 1990 1995 2000 2005 2010

Bank lending rates v/s GDP Growth Rate

% Growth in
YEAR GDP INDIA lending rates

1987 16.5
1988 7.359732163 16.5
1989 -2.500134416 16.5
1990 4.53595456 16.5
1991 -12.33135776 16.5
1992 -0.766594761 16.5
 1993 -4.066628061 19
1994 11.0989261 19
1995 11.19853671 15
1996 0.761056423 16.5
1997 10.15718025 14.5
1998 -1.137626012 14
1999 4.998950927 13
2000 1.845055318 12
2001 0.563327469 11.5
2002 3.007238444 11.5
2003 14.01362491 10.75
2004 14.97676033 10.25
2005 15.16242242 10.25
2006 10.3708774 10.25
2007 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 SS MS F Significance F
Regression 1 363.5838 363.5838 6.870023 0.017314
Residual 18 952.6183 52.92324
Total 19 1316.202

Coefficients
Standard Error t Stat P-value Lower 95% Upper 95%Lower 95.0%
Upper 95.0%
Intercept 26.30944 8.052966 3.267049 0.004281 9.390781 43.22809 9.390781 43.22809
X Variable 1 -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 Total Credit % change in total credit % Growth in Production
2001-02 59322
2002-03 69,560 17.26 6.084396467
2003-04 86,981 25.04 8.254963427
2004-05 1,25,309 44.06 1.544401544
2005-06 1,36,899 9.24 4.27756654
2006-07 1,58,076 15.49 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
Significanc
df SS MS F eF
1.44447 1.44447 0.11129
Regression 1 5 5 8 0.760628
Residual 3 38.9352 12.9784
40.3796
Total 4 8

Coefficien Standar Upper Lower Upper

ts d Error t Stat P-value Lower 95% 95% 90.0% 90.0%
-
3.38396 1.51728 0.22647 15.9037 2.8292 13.0981
Intercept 5.134431 3 4 6 -5.63485 1 6 3
-
0.13392 - 0.76062 0.38153 0.3598 0.27050
X Variable 1 -0.04468 8 0.33361 8 -0.4709 9 6 1

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 .
 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 .