BANKING AND FINANCIAL REFORMS

Banking and Financial Reforms in Emerging Markets

Banking and Financial Reforms in Emerging Markets

India initiated far reaching reforms in 1991 involving integration with the world economy in a market-consistent manner, and rebalancing of the state-market mix in favor of the latter. The emphasis has been on enhancing competition, while strengthening prudential regulation. This has provided much greater scope for entrepreneurship, and for harnessing external sector for growth. India's remarkable economic performance over the last two decades has been primarily private sector led. The essential complimentarity between the private and public sectors (and more broadly between the state and the market), however, needs to be reflected in public policies to a much greater extent if India is to achieve and then sustain even higher growth trajectory, and make rapid progress in improving the quality of life. Financial and capital market reforms have been an important component of the overall economic reforms in the country (RBI, 2005a).

Cooperative Banks which have been in existence for a century in India are found in both rural and urban areas. The former is assigned responsibilities for providing institutional credit to agricultural and related activities in the rural areas; while the mandate of the urban cooperative banks (UCBs) is to cater to urban areas[1] (RBI, 2006b). It is only recently that the policymakers have begun to focus on aligning the operations and governance of the cooperative banking sector with current and prospective internal and external environment facing India in general, and the cooperative sector in particular.

As at end-March 2006, there were 1,853 UCBs in India with total assets/liabilities of INR 1,403.3 billion (USD 31.3 billion), equivalent to 5 percent of the assets of the scheduled commercial banks (RBI, 2006b). Even though assets of the UCBs are relatively small in aggregate terms, they are significant in meeting the banking needs of middle and lower income persons, many of whom are small traders and business persons in those semi-urban and urban areas which have insufficient access to banking services.

The current functioning of the UCBs reflects the pre-1991 economic regime, with high degree of politicization in their functioning, and reliance on non-market, non-competitive mechanisms. As a result, professionalism, technological, modernization, new business models, and rationalization have not received adequate attention (RBI, 2005b). One of the consequences has been that nearly two-fifths of the UCBs are officially classified as “financially weak” [2].

Potential developmental role of the UCBs is indicated by the fact that their total advances in 2005-2006 to economically weaker sections and to priority sectors[3] were Rs. 475 billion equivalent to 69 percent of total advances (RBI, 2006). The interest rates charged by the UCBs, which are in the range of 12-15 percent per annum, is one-third to one-fourths the rates of money lenders, the main alternative source of funds.

The above suggests that in spite of their relative small size, the health of the UCBs is important for the overall banking system, and for the key development objectives of financial inclusion and broad-based economic ...