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Narrow Banking: Theory, evidence and prospects in India

Author

Listed:
  • 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.

Suggested Citation

  • Ghosh, Saibal & Saggar, Mridul, 1998. "Narrow Banking: Theory, evidence and prospects in India," MPRA Paper 17352, University Library of Munich, Germany.
  • Handle: RePEc:pra:mprapa:17352
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    File URL: https://mpra.ub.uni-muenchen.de/17352/1/MPRA_paper_17352.pdf
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    References listed on IDEAS

    as
    1. Mishkin, Frederic S, 1994. "Preventing Financial Crises: An International Perspective," The Manchester School of Economic & Social Studies, University of Manchester, vol. 62(0), pages 1-40, Suppl..
    2. Caprio, Gerard Jr. & Summers, Lawrence H., 1993. "Finance and its reform : beyond laissez-faire," Policy Research Working Paper Series 1171, The World Bank.
    3. Biaggio Bossone, 2001. "Should Banks Be Narrowed?," IMF Working Papers 01/159, International Monetary Fund.
    4. Neil Wallace, 1996. "Narrow banking meets the Diamond-Dybvig model," Quarterly Review, Federal Reserve Bank of Minneapolis, issue Win, pages 3-13.
    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, vol. 18(1), pages 105-118, May.
    6. P. Honohan, 2000. "Banking System Failures in Developing and Transition Countries: Diagnosis and Prediction," Economic Notes, Banca Monte dei Paschi di Siena SpA, vol. 29(1), pages 83-109, February.
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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.

    More about this item

    Keywords

    Narrow banking; government securities; deposit insurance; India;

    JEL classification:

    • G21 - Financial Economics - - Financial Institutions and Services - - - Banks; Other Depository Institutions; Micro Finance Institutions; Mortgages

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