Banking in India

Commercial banks play a very important role in the economy of any country. They constitute the most useful intermediary in the financial markets, who have a vital role in ensuring the efficacy of all monetary and fiscal measures. Their continued good health and sustained viability are therefore of immense significance for any economy. Measures to ensure their well-being are of paramount importance in order to maintain a high level of investor confidence. In India, financial liberalization has opened up new vistas for the commercial banks and they can now operate as universal banks offering, under one roof, all kinds of financial services including project financing and leasing. Besides, banks are allowed to go in for investment in securities also. However, the guidelines for direct lending have not been touched so far. Consequently, there are restrictions on the ways in which banks in India can deploy their available resources. In this article, an analysis has been carried out to show how such structural restrictions translate into what is often termed as interest rate rigidities for banks. How the loan losses impact on their interest spread as well as the urgent need to improve the framework for recovery of banks' NPAs has also been gone into. Moreover, the scope for moral hazards in banks, which are limited liability entities, has been explored and need for efficient risk management as well as effective risk-based supervision for ensuring their sustained viability has been analyzed and commented upon. A cut-off risk for bankable projects has also been worked out. The findings are interesting because the analysis takes into account the real life constraints faced by the banking sector and the results reflect the realities of this sector.