2047639R MTBF

Economics MSc 2012-13

Student number:

2047639R

MSc Programme: International Banking and Finance

Course name: Modern Theory of Banking andFinance

Submission date:

18th March, 2013

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Essay on: The process of financial development and financial

liberalization in India over the last few decades, and changes

in the financial regulation and the evolution of the banking

sector.

India is one of the fastest developing countries in the world.

Sen and Vaidya (1997) suggested that the evolution of the

financial sector was divided into three parts. The first one

was from (1947-68) where the Reserve Bank of India (RBI) was

in charge for everything from supervision to control of the

banks. The second period was from (1965-1985) which was known

as the financial repression as 14 commercial banks were

nationalized. The third and the last period was from 1985

onwards when the financial sector was diversified and

liberalized as suggested by Das and Drine (2011). The main

development in the finance industry and the Indian economy

came after the 1990’s when the financial liberalization began.

If we talk about the financial development and financial

liberalization in the last two decades, India mostly (Urban

India) has gone through a total make-over. Most of the changes

have taken place in the industrial sectors such as

Telecommunication, Retail, Aviation and Banking. Chakrabarti

(2010) suggested that the Indian Financial Market has gone

through it’s greatest transformation with the help of (SEBI)

Securities & Exchange Board of India, (NSE) National Stock

Exchange. The new rules and regulation set up by the

government of India led to an increase in the volume of trade

in the equity market. With the help of SEBI around 70% of the

equity trading was captured by the NSE.

Using the data provided in Chart 1 by Abiad, Detragiache and

Tressel (2008) we could see the progress of India after the

1985. Since 1990’s the post liberalization period, we notice

that India started catching up with other Asian countries.

In the mid- 1990’s many new private banks started operations

in India and the public sector gained more momentum. There

were better customer services, new ways of banking and new

technology was involved. The mutual fund and the insurance

companies started opening up to these private banks. After

setting up many reforms, India was still developing at a slow

rate. Mckinsey (2006) found that from the year 2001, the

financial sector of India started getting more stability.

Figure-1

If we look at Figure1, the change in the derivatives market is

evident as there is a drastic improvement after the year 2003-

04. As that year there were new regulations and SEBI became

more powerful. The last decade has been really important in

the improvement of the Indian economy. The turnover is more

than thrice from 2003-04 to 2006-07.

The Financial Sector Legislative Reform Commission (FSLRC) is

the body which makes regulations that affect the financial

markets in India. Recently, as inspired by countries like

Australia and Canada, they are trying to set up a financial

regulation to protect the consumer against unfair practices by

banks and some other financial intermediaries. The Government

of India is working on it and trying to adopt new regulations

and enforce strong laws as stated by Patnaik (2012). Some of

the recent financial regulations in the year 2008 &2009 are as

follows:

1. RBI had liberalized external commercial borrowings (ECB)

to ensure the availability of easy debt.

2. Buybacks of the foreign currency convertible bonds (FCCB)

which was made common to raise corporate finance has some

new policies involved in it.

3. Outbound Investment restrictions were imposed to limit

the flow of investment outside India.

4. All the above legislative measures helped India fight

recession and a revised FDI policy was also introduced

for the protection of the Indian companies.

Chart 2: Herfindahl Index for the Banking Sector

Source: Gupta et al (2011), IMF working paper no. 50

When we look at the efficiency and competition level for the

banks, Gupta et al (2011) emphasized that there was a decline

in the number of banks. As more foreign and private banks

started entering India, there was a sharp decline of banks in

the early 2000’s. This actually had a positive impact as the

banks became more efficient with their services and by the

year 2007 there was almost a balance between the public and

private sector banks. Chart 2 explains this scenario, as

Herfindahl index which consists of shares in assets for all

banks, including the foreign ones shows us the decline in the

number of banks.

Singh and Weisse (1998) in their paper mentioned that as India

is one of the emerging markets in the world, the equity market

is expanding very fast. After the changes in the policies and

when liberalization was being implemented at a fast pace, in

the end of year 1995 the Indian Stock market was the largest

in the world. It had around 7985 listed companies which

surpassed all the other stock exchanges in the world. If we

look at the current scenario, India has attracted a lot of

Foreign Direct Investment (FDI), and now the stock market has

a lot of options for the investors as it is more diversified.

There are options, futures, commodities, equities, bonds etc

and it depends on the investor as to how much risk they are

willing to take. In the long run and the coming future there

will be more and more investors involved in the stock market.

Chart 3: The Journey of the Indian Stock Market since 1991.

Source: Deepak Shenoy (2013), Capitalmind.in

If we take a look at Chart 3, it shows us the change from the

year 1991, when the stock market had a positive growth. Till

the year 2003, the Indian equity market was stagnant and there

were negative returns for 11 consecutive years. Then came the

sudden change which was the boom (2003-07) for the Indian

stock market as the sensex almost tripled its value and it was

definitely the best years for business in the Indian stock

market. If we look at the year 2008, which was the year of

recession all over the world, there was a big crash in the

stock markets of the world as well, the sensex was also

affected majorly, but the surprising factor is the way it

recovered (the V shaped recovery).

References:

Abiad Abdul, Enrica Detragiache, Thierry Tressel, 2010. "A NewDatabase of Financial Reforms," IMF Staff Papers, Palgrave Macmillan Journals, vol.57(2), pages 281-302.

AJIT SINGH and BRUCE A. WEISSE. (1995). Emerging StockMarkets, Portfolio Capital Flows and Long-term EconomicGrowth: Micro and Macroeconomic Perspectives . World Development.26 (4), 607-614.

Deepak Shenoy. (2013). Subbarao on the Economy, With InterestingGraphs. Available: http://capitalmind.in/2013/03/subbarao-on-the-economy-with-interesting-graphs/. Lastaccessed 16th March,2013.

Gupta, P., Kochhar, K., Panth, S., 2011. Bank Ownership andthe Effects of Financial Liberalization: Evidence from India,IMF Working Paper no. 50

Ila Patnaik (2012), Towards better financial Regulation, TheFinancial Express, 2nd October,2012.

McKinsey, 2006, “Accelerating India’s Growth through Financialsystem reform”, McKinsey Global Institute.

Nirupam Bajpai and Jeffrey D. Sachs. (2011). India's Decade ofdevelopment. CGC. 3

Rajesh Chakrabarti. (2010). Financial Development in India:Status and Challenges. Social Science Research Network. E44, G18, 1-3.

Santosh Kumar Das, Imed Drine. (2011). FinancialLiberalization and Banking Sector: Efficiency inIndia. International Business and Management. 2 (1), 42-58.

Sen, Kunal & R.Vaidya (1997), “ The Process of FinancialLiberalization in India”, Oxford University Press, Delhi.

Shardul Thacker. (2010). Indian Legislation: Changes in thewake of the Global financial turnmoil. FICCI (Federation of IndianChambers of Commerce and Industry), 400-401.