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Narrow Banking: Theory, evidence and prospects in India

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  • Ghosh, Saibal
  • Saggar, Mridul

Abstract

The narrow banking proposal defining a class of safe and liquid assets (generally sovereign Government securities) for investments by weak banks, backed fully by demand liabilities (generally non-interest bearing deposits) has been considered as a means of deposit protection and a possible solution to the banking problems. The paper seeks to explain the theoretical implications of the proposal and examine its implications for the Indian public sector banks facing large non-performing loans. The evidence presented shows that even without a directive, narrow banking on the asset side is already being practised as part of the asset-liability management by these banks. However, given the structure of deposit ownership, narrow banking in its strict sense does not afford a solution to reforming weak banks. Strictly practiced narrow banking can neither guarantee deposit protection not turn around the weak banks. On the contrary, it may expose weak banks to immense market and interest rate risks which can make the banking system vulnerable to idiosyncratic and systemic risks arising from macroeconomic shocks. The paper however recognises that some contraction in the scale of operations of weak banks seems to be an unavoidable by-product of measures which may be necessary to strengthen weak banks.

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Bibliographic Info

Paper provided by University Library of Munich, Germany in its series MPRA Paper with number 17352.

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Date of creation: May 1998
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Publication status: Published in Economic and Political Weekly 9.34(1998): pp. 1091-1103
Handle: RePEc:pra:mprapa:17352

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Keywords: Narrow banking; government securities; deposit insurance; India;

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References

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  1. Neil Wallace, 1996. "Narrow banking meets the Diamond-Dybvig model," Quarterly Review, Federal Reserve Bank of Minneapolis, Federal Reserve Bank of Minneapolis, issue Win, pages 3-13.
  2. Patrick Honohan, 1997. "Banking system failures in developing and transition countries: Diagnosis and predictions," BIS Working Papers 39, Bank for International Settlements.
  3. Frederic S. Mishkin, 1994. "Preventing Financial Crises: An International Perspective," NBER Working Papers 4636, National Bureau of Economic Research, Inc.
  4. Biaggio Bossone, 2001. "Should Banks Be Narrowed?," IMF Working Papers 01/159, International Monetary Fund.
  5. Kobayakawa, Shuji & Nakamura, Hisashi, 2000. "A Theoretical Analysis of Narrow Banking Proposals," Monetary and Economic Studies, Institute for Monetary and Economic Studies, Bank of Japan, Institute for Monetary and Economic Studies, Bank of Japan, vol. 18(1), pages 105-118, May.
  6. Caprio, Gerard Jr. & Summers, Lawrence H., 1993. "Finance and its reform : beyond laissez-faire," Policy Research Working Paper Series 1171, The World Bank.
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Cited by:
  1. Bhide, M G & Prasad, A & Ghosh, Saibal, 2001. "Emerging Challenges in Indian Banking," MPRA Paper 1711, University Library of Munich, Germany.

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