CHAPTER IV

FINANCIAL INTERMEDIARIES IN INDIA

" The principal function of financial intermediaries is to purchase primary securities from ultimate borrowers and to issue indirect debt for the poitfolios of ultimate lenders ..... All financial intermediaries create financial assets."

- John Gurley and Edward Shaw Money in a Theory of Finance, f960.

Basic Concepts and Terminology

Generally, the term financial intermediary or financial institution refers to

those institutions that are engaged in bringing together the ultimate borrowers

(users) and ultimate lenders (providers) of finance. The financial intermediaries

/institutions can be categorised as: first, those who borrow for themselves in order to

lend to others. In other words, they create claims on others. These institutions

~nclude commercial and co-operative banks, term lending institutions or depository

institutions, or development banks, investment institutions, such as insurance

companies and unit trusts etc; second, those institutions which bring together the

borrowers and lenders, buyers and sellers of securities without entering into a

transaction as principals. In other words, these are non-banking financial

intermediaries/institutions which create claims that do not form part of the money

stock. The act of transferring savings or financial resources from 'surplus' units to

deficit' units by a financial intermediary is called financial intermediation. The

financial intermediaries charge a fee, which is called the intermediation cost.

230 As it is recognised that different balance sheet variables have varied

implications for current economic behaviour, it is important to distinguish between

financial assets and tangible assets. A financial or intangible asset includes money,

bonds and equities, which represent a legal claim on some future benefit or income.

It is interchangeably also referred to as financial instwment or securities. A financial

asset can be classified into debt instrument or equity. The price of a financial asset

is equal to the present value of its expected cash flow. The degree of certainty of

the expected cash flow can be determined based on the characteristics of the

issuer. The principal and services of financial assets are predominantly generalised

claims against current production and are usually fixed in nominal money units tied

to future contingency or represent pro-rata shares in returns of enterprises. Financial

assets are primarily held as an attractive income-earning store of purchasing power.

On the other hand, tangible assets are material things, which are unique in

both form and use. Their annual return in the form of productive or consumable

services are in kind and must be sold to convert into another form of wealth or

income. Essentially, tangible assets are primarily held for the physical services that

they directly yield, such as machines, houses and consumer durable goods.

Forms of Financial Intermediation

Financial intermediaries undertake various forms of intermediation.

Denomination intermediation takes place when intermediaries pool in small

savings from individuals and provide large loans mainly to corporation and

231 governments. Default-risk intermediation occurs when financial intermediaries

provide loans to risky borrowers and simultaneously issue relatively safe and liquid

securities to attract loanable funds from savers. Maturity lntennediation occurs

when financial intermediaries borrow short-term funds from savers and make long-

term loans to borrowen. Maturity intermediation is most often undertaken by many

financial intermediaries. Infomation lntermediation takes place when financial

intermediaries substitute their skills in the market place for that of the savers who

most often do not have the time to stay abreast of market conditions or have access

to relevant information and market opportunities. Risk pooling and achieving

economies of scale in their operations are the other important considerations in

intermediation. Financial diversification, stability in earnings and cash flow besides,

enhancing safety of funds and spreading risks are the major advantages of investing

in assets having different risk-return combinations. Similarly, lower operating costs

per unit and lower cost of financial services are achieved through increasing the

size.

Moore (1968) distinguishes between monetary and non-monetav financial

intermediation. Monetary and non-monetary financial intermediaries exist due to the

differential between the lending rate they are able to charge borrowers and the

borrowing rate that they must pay to the lenders. Under monetary

cOntrollregulations, while the assets and liabilities of the monetary intermediaries are

subject to additional restraint in the form requirements, the non-monetary

intermediaries are not subject to such reserve requirements. However, the non-

232 monetary intermediaries are subject to regulation in terms of composition of their

assets and liabihties.

Types of Financial Intermediaries

In terms of types of financial markets, financial intermediaries can be

classified into Money market intermediaries and Capital market intermediaries.

Since money market is concerned with supply and demand for investible funds, it is

essentially, a short-term market where funds are lent and borrowed. Money market

intermediaries comprise commercial banks and other agencies, such as indigenous

bankers, discount houses and other financial institutions which supply short-term

capital requirements to different sectors of the economy and the central bank of the

country which acts as the apex institution of the money market. As the capital

market is concerned with medium and large financial needs of business and other

undertakings, Capital market intermediaries provide medium and long-term loans to

these borrowers.

Depending upon the purposes of analysts, policy makers and researchers

financial intermediaries can be classified into Depositow intermediaries like banks

and Contractual intermediaries like insurance companies. While Depositories

intermediaries accept deposits from the public and are the principal repository of

savings in the economy, the contractual intermediaries can not accept deposits from

the public. While the timing, the amount parked with and withdrawals in a depository

intermediary is flexible and easy, in the case of contractual intermediaries, it is

233

usually specified as per the contract or agreement between the saver and the

institution.

Functions of Financial Intermediaries

The main functions of financial intermediaries are to mobilise savings from

the surplus economic unit and transfer them as productive investments to the deficit

economic unit and sewe as an efficient conduit for payments. Gurley and Shaw

(1960) point out that 'the principal function of financial intermediaries is to purchase

primary securities from ultimate borrowers and to issue indirect debt for the

portfolios of ultimate lenders:

According to Gurley and Shaw, financial intermediaries have an important

function in providing a market mechanism for the transference of claims on real

resources from savers to the more efficient investors. The more perfect the financial

market, the more nearly is the optimum allocation of investment. Financial

transactions and financial instruments have two distinct types of effect on economic

behaviour corresponding to flow and stock relationships. The first is the

'Intermediation Effect: which is as a result of properties of the financial assets

which tangible assets do not possess. Indirect exchange through the intermediation

of financial inst~ments is technically a more efficient means of want satisfaction

than direct exchange. Intermediation of money, which is generally accepted as a

means of payment, permits purchase and sale of commodities decomposed into two

acts, which are special in time. Consequently, the use of money eliminates the

234 difficulties experienced in exchange in a barter system. In addition to the effects of

financial transactions in facilitating enlarging and intermediating the flow of

economic exchange, financial instruments play a fundamental role in production,

integration and ownership of wealth, the creation of economic activity. These stock

implications of financial assets termed as 'Asset Transmutation Effect' follow

likewise, from observation that financial goods possesses characteristics which

tangible goods do not, so that the indirect ownership of real wealth through the

holding of financial assets is a technically more efficient means of want satisfaction

than the direct ownership of tangible assets (Gurley and Shaw, 1960)

According to Tobin and Brainard (1963) the essential function of any financial

intermediary is to meet the portfolio choices of borrowers who wish to expand their

holdings of real assets and lenders who wish to hold part or all of their net worth in

assets of stable money value with negligible risk of default. They observe, "The

assets of financial intermediaries are obligations of the borrowers - promissory

notes, bonds, mortgages. The l~abilities of financial intermediaries are the assets of

the lenders - bank deposits, savings and loan shares, insurance policies, pension

rights." According to them, financial intermediaries are distinct from each other in

terms of providing differentiated products to both lenders and borrowers.

Furthermore, they point out that "each intermediary has its speciality" or uniqueness

In terms of credit offered. Besides, there is product differentiation within

intermediaries, as between institutions arising out of locational, advertising and other

monopolistic advantages. From the lender's point of view, the obligations of various

235 financial intermediaries are but not perfect substitutes. Besides, the financial

intermediaries 'assume liabilities, which are of smaller default risk and greater

predictability of value than their assets'. Accordingly, the reasons that the

intermediation of financial institutions can perform these asset-liability

transformations are: administrative economy; expertise in negotiating, accounting,

appraising and collecting; reduction of lending risk per unit of money with respect to

loan default and deposit withdrawal; guarantees of liabilities of institutions which

assure solvency and liquidity of the institutions.

In the unregulated banking models of Black (1970) and Fama (1980),

competitive financial intermediaries perform two major functions; viz., manage

portfolios for depositors and provide accounting systems for exchanging claims

against depositor's wealth. Fama (1980) shows that competitive financial

intermediaries, like banks, provide a diversified portfolio against which depositors

hold claim. The competitive intermediary charges marginal cost for the provision of

transactions and portfolio management services. The returns on deposits are equal

to those in other portfolios with the same level of risks. AS deposits have no

opportunity costs, it does not imply that the bifurcation of total wealth into deposits

and non-deposit claims are indeterminate. Besides, an indeterminate supply of

deposits does not imply an indeterminate price level as the price level of goods

depends upon its demand and supply conditions in the market and also of other

goods.

236 Another important function of financial intermediaries is brokerage and the

economic rationale for the emergence of financial intermediaries is their ability to

lower information production costs. Niehans (1980) observes

Similarly, financial intermediaries may be brokers, middlemen or

dealers in assets, bringing borrowers and lenders together at lower

costs than if the parties had to get together directly. The basis of

their existence, from this point of view, - is the cost of evaluating

credit risks. In a competitive system - the interest they receive -

simply reflects their own marginal transactions costs. As dealers,

financial intermediaries do not transform the claims they help in

exchange. Their assets and liabilities relate to funds of the same

type; in particular, they have the same liquidity or "moneyness". An

impressive example of a highly developed intermediary system in

which the brokerage function predominates is the Eurodollar

market.

The economic function of financial intermediaries can be generalised as

follows (Rangarajan, 1997):

(i) liability-asset transformation (i,e., accepting deposits as a liability and converting

them into assets such as loans);

(ii) size-transformation (i.e., providing large loans on the basis of numerous small

deposits);

237 (iii) maturity transformation (i.e., offering savers alternate forms of deposits

accepting to their liquidity preferences while providing borrowers with loans of

desired maturities), and

(iv) risk transformation (i.e., distributing risks through diversification, which

substantially reduces risks for savers, which would prevail while lending directly in

the absence of financial intermediation).

The process of financial intermediation supports increasing capital

accumulation through the institutionalisation of savings and investment and, as

such, fosters economic growth. The gains to the real sector of the economy,

therefore, depend on how efficiently the financial sector performs this basic function

of financial intermediation. In the process of transforming savings to investment,

financial intermediaries perform an important function of absorbing liquidity through

changes in spread between lending and borrowing rates for banks and

commissions, fees etc., for brokers and dealers. According to Pagano (1993), this

absorption of liquidity is limited by taxation, reserve requirements and other

restrictive and regulatory trading practices that influence the proportion of savings

diverted to investments and also the social marginal productivity of capital. Lastly,

another important function of financial intermediaries according to Pagano (1993) is

their ability to allocate funds to projects with highest marginal of product which is

increased by collection of information and inducing individuals in risky projects by

offering risk-sharing.

238 Financial Intermediaries in India

As explained in the previous chapter, owing to the heterogeneous needs of

the various segments of the economy, a variety of financial intermediaries have

emerged in India. For the purposes of compilation of total assets, a wide range of

institutions have been included, such as Reserve Bank of India, banking system.

public financial institutions, Mutual Funds, non-banking financial companies etc.

The data are compiled from various published sources and from the balance sheets

of the respective institutions. In the case of certain institutions, gaps in the data have

been filled in by extrapolation based on trends. Similarly, the data on investments

and credit /loans was not available on a continuous time-series basis. For instance,

in the case of Unit Trust of India, loans were provided only since 1985 as a matter of

policy. Since 1993-94, their magnitude has declined, again as a matter of policy.

Mutual funds being investment- oriented institutions do not provide credit/loans.

While extrapolating the data for one or two years for many institutions, the above

specific factors have also been taken into account so that the estimates are nearer

to accuracy. One of the problems encountered while consolidating the balance

sheets of various financial institutions was that there are differences in the closure

date of books of accounts. Some of the institutions closed during June while others

closed in December. However, since 1989, with rationalisation of accounting

Practices, it became mandatory for all financial institutions to close their books of

accounts in March, to coincide with the financial year. Further, these are outstanding

amounts at a particular date during a year and hence relate to stock variables.

Besides, these data reflects book values held on market value basis. The total

239 assets represent both intangible and tangible assets of financial institutions.

Generally, it has been observed that the tangible assets account for about 2 per

cent to 5 per cent of the total assets. The data also is not exclusive of inter-

institutional flows since as per the flow of funds accounting, one institution's asset is

another institution's liabilities.

For the purpose of this study, financial intermediaries in lndia are grouped

into four categories, viz., (i) Banking Intermediaries; (ii) Financial Institutions (Fls)

including development Banks or term-lending or development financial institutions at

the national and state levels, investment institutions, specialised institutions and

other institutions; (iii) Mutual Funds (MFs); and (iv) Non-bank Financial and

Investment Companies (NBFICs). It is also to be noted that the assets of Primary

Dealers (PDs) (1995), Satellite Dealers (SDs) (1996) in Government securities

market, regulatory institutions like, Securities Exchange Board of lndia (SEBI)

(1992), custodial services institutions Stock Holding Corporation of lndia Ltd., 1987)

and Depository institutions (National Securities Depository Ltd.,1996) have been

excluded from the analysis as these institutions are either market- making or

regulatory or custodialldepository institutions.

A review of the operations of these institutions in terms of their trends in

assets, Sources and Uses of Funds, and trends in Income and Expenditures are

separately presented below.

Trends I n Growth of Total Assets of Financial lnstitutlons

The total assets of financial institutions including Reserve Bank of India in

terms of stock (nominal face value) increased by over 433 times from Rs. 3,095

crore in 1950 to Rs. 13,40,539 crore in 1997 representing an annual average

compound growth rate of 13.8 per cent. It implies doubling of assets every seven

and quarter years approximately. In order to keep in line with the trends in the

financial development and changes in the financial structure, the analysis is broken

down to sub-periods, viz., (a) between 1950 to 1969 to coincide with the beginning

of the planning for economic growth and pre-nationalisation of the major scheduled

commercial banks in India; (b) Between 1970 to 1986 to coincide with the post-

nationalisation and consolidation of the banking system; and (c) between 1987 to

1997 which represents the period of liberalization, diversification and reforms.

As per the periodisation, in terms of level and average growth, the total

assets including RBI (Goldsmith, 1983) grew from Rs.3,095 in 1950 to Rs.14,928

crore in 1969 at a lower rate at an annual average compound growth of 8.6 per cent

as compared with the average rate of growth for the whole period. During the period

11 (1970-86), it increased from Rs.16,637 crore to Rs.2,42,830 crore at the peak rate

at 18.2 per cent while during period 111 (1987-97), it grew from Rs.2,78,970 crore to

Rs.13,40,539 crore at 17.0 per cent which was higher the average rate of growth for

the whole period (Table IV.1 and 1v.2). Thus, it can be observed that the annual

average compound growth of total assets of all financial institutions including

24 1 Reserve Bank of lndia during the period 1 (1950-69) more than doubled in the period

11 (1970-86) and marginally declined to 17.0 per cent in the period 111 (1987-97).

For the purposes of analysis, following Goldsmith (1958), the central bank

assets were deducted from the total assets to arrive at total assets excluding

Reserve Bank of India. Such a distinction has a considerable significance in the

Indian context, since Reserve Bank of India's assets duplicates those of the

commercial banks and All Financial Institutions (AFls).

The total assets of all financial intermediaries excluding Reserve Bank of

lndia in terms of stock (nominal face value) increased by 748 times from Rs.1,483

crore in 1950 to Rs. 11,09,520 crore in 1997 representing an annual average

compound growth of 15.1 per cent. As per the periodisation, in terms of level and

average growth, the total assets grew from Rs.1,483 in 1950 to Rs.10,251 crore in

1969 at an annual average compound growth of 10.7 per cent as compared which

!,,as marginally higher than the growth rate when the Reserve Bank was included.

During the period 11 (1970-86), it increased from Rs.11.654 crore to Rs.1,88,530

crore at the peak rate at 19.0 per cent while during period 111 (1987-97), it grew from

Rs.2,16,528 crore at 17.8 per cent which was higher the average rate of growth for

the whole period (Table IV.2).

It can be observed that annual average rate of growth of total assets

excluding Reserve Bank of India assets exhibited a similar trend as in the case of

242 total assets including Reserve Bank of lndia thereby reflecting the higher growth rate

of assets of banks and non-banks as compared with those of Reserve Bank of India.

Share o f Main Types of Financial Institutions i n Total Assets

The assets of banking system increased from Rs.1,136 crore in 1949-50 to

Rs.6,04,397 crore in 1996-97 at an annual average compound rate of 14.3 per cent,

that of Reserve Bank of lndia increased from Rs.1.612 crore to Rs.2.31,019 crore at

an annual average compound rate of 11.1 per cent, National-level term lending

financial intermediaries from Rs.ll.0 crore to Rs.1,38,572 crore at the rate of 22.2

per cent, Investment Institutions from Rs. 250 crore to Rs.2,70,459 (14.9 per cent)

and Small savings from Rs.86 crore to Rs.1,06,111 crore at the rate of 10.8 per cent

during the same period. Of the Small savings, the Post Office Saving Deposit rose

at the rate of 10.3 per cent and that of Provident and Pension Funds grew at 18.1

per cent per annum (Table 2). It is observed that during the initial stages of

development, the share of Reserve Bank of lndia assets in the total which was as

high as 52 per cent, drastically declined by one third to 17 per cent.

The share of banking system in the total assets including Reserve Bank of

India, topped at 88.8 per cent (with Reserve Bank having 52.1 per cent share and

banks with 36.7 per cent) in 1950. This was followed by investment institutions (8.1

Per cent), small savings (2.8 per cent) and financial Institutions (0.3 per cent)

indicating a high level of monetisation of the economy. During 196869, although

the share of banking system declined to 68.6 per cent due to a steep fall in the

243 share of Reserve Bank of lndia assets from 52.1 per cent in 1950 to 31.3 per cent in

the same period. The Small savings became more attractive with its share reaching

12.7 per cent as compared with the share of investment institutions at 12.3 per cent

during the same period. There was also a perceptible increase in the share of

National and State-level financial institutions (5.3 per cent) and Non-bank financial

companies (1.1 per cent).

in the period II, the share of banking system in the total assets including

Reserve Bank of India, continued to top at 68.5 per cent in 1970 followed by

investment institutions (12.5 per cent), small savings (12.2 per cent) and national

and State level financial Institutions (5.4 per cent). During 1985-86, although the

share of banking system increased to 71.0 per cent and the share of Reserve Bank

of lndia assets continued to remain constant at 22.4 per cent in the same period.

The Small savings became less attractive with its share reaching 9.2 per cent along

with the share of investment institutions at 8.1 per cent during the same period.

There was an increase in the share of national and state-level financial institutions

(9.1 per cent and 1.9 per cent) and non-bank financial companies (0.4 per cent).

The same trend continued in 1986-87 and during 1996-97, the share of banks

topped with 45.1 per cent while that of the Reserve Bank further declined to 17.2 per

cent. The specialised institutions came into being only in the early 'nineties and

their share increased to 1.0 per cent in 1996-97. Since its commencement of

business in late 1987, the share of mutual funds rose to 0.9 per cent in 1996-97.

244 It can be seen from Table IV.l that there is a significant change in the asset

distribution with the exclusion o f Reserve Bank of India assets in the total. The

share of banking system in the total assets excluding Reserve Bank of India, topped

with 76.6 per cent in 1950 followed by investment institutions (16.9 per cent), small

savings (5.8 per cent) and term-lending Institutions (0.7 per cent). In the end of

period I, the Small savings became more attractive with its share reaching a peak of

18.6 per cent in 1969 as compared with the share of investment institutions at 17.9

per cent during the same period. There was also a perceptible increase in the share

of national and state-level financial institutions (5.3 per cent) and Non-bank financial

companies (1.1 per cent). The trend reversed in the case of banking system with its

share rising from 55.1 per cent in 1969-70 to 62.6 per cent in 1985-86 and thereafter

gradually declined to 54. 5 per cent in 1996-97. The share of term-lending financial

~nstitutions and State-level institutions substantially increased from 7.7 per cent in

1969-70 to 14.5 per cent in 1996-97. The share of investment institutions declined

gradually from a high of 17.8 per cent in 1970 to a low of 10.4 per cent in 1985-86

but picked up since then to reach 15.4 per cent in 1996-97. There was no change

with regard to asset distribution in the case of other institutions. The Specialised

institutions came into being only in the early 'nineties and their share stood at 1.3

Per cent in 1996-97. The share of Non-banking financial companies showed

marginal increase from 1.4 per cent in 1969-70 to 2.9 per cent in 1996-97 and that

Of small savings showed gradual decline from 17.4 per cent to 9.6 per cent during

the same period. Since its commencement of business in late 1987 the share of

mutual funds stood at 1.1 per cent in 1996-97.

245 The trends in grwrth of assets of all financial institutions coincides with the

fad that during the period I, foundations were laid with the establishment of new

Institutions, such as Industrial Finance Corporation of India, Industrial Credit and

Investment Corporation of India, Life Insurance Corporation, Industrial Development

Bank of India, Unit Trust of India. While these institutions along with the banking

Institutions grew in the period II, in the last period, further growth and qualitative

changes were brought in through liberalisation, diversification and reforms measures

were undertaken in the context of foreign exchange crisis, accumulation of large non

performing assets by banks and it was during this period structural adjustment

programme was initiated.

It is also observed that a similar pattern of growth prevailed for the banks and

the non-banks (which includes financial institutions, non-banking financial and

~nvestment companies and mutual fund institutions). The overall growth rate for non-

banks and banks were higher than that of all financial institutions; although non-

b&.iks grew at a faster rate than banks in all the periods under reference except in

the sub-period II (Table IV.l). This reflects the spectacular growth in the banking

system since their nationalisation. It may be noted that the average growth rates for

state-level institutions (SLls) decelerated as compared with that of the term lending

Institutions (TLls) and mutual funds institutions (MFs). This shows that the banking

SYsrem dominated the financial system and higher rate of growth have been

bshieved on account of post-nationalisation of the major commercial banks, various

ilberalisation policy measures and reforms undertaken since 1969.

246 I t is also observed from Table IV.3 that the rate of growth of assets of all

financial institutions excluding Reserve Bank of lndia has been higher than the rate

of growth in total assets induding Reserve Bank of lndia and Gross Domestic

Product at current market prices and Gross National Product during all the sub-

~eriods.

The time series data on total assets are affected substantially by the

fluctuations in the exchange rate. These fluctuations are generally eliminated by

deflating all the values by the Wholesale Price lndex (WPI) or by Gross Domestic

Product or Gross National Product deflators. Using Wholesale Price lndex deflator.

the compounded rate of growth of assets of all financial institutions including

Reserve Bank of lndia is lower at 9.9 per cent during 1951-97 reflecting the upward

movement in prices during the most part of the period in the last 47 years; with the

exclusion of Reserve Bank of lndia it was 10.9 per cent. Using the Gross Domestic

Product deflator, the compounded rate of growth of total assets of all financial

institutions including Reserve Bank of lndia worked out to 9.5 per cent and 10.5 per

cent after excluding Reserve Bank of lndia assets. if the total assets of all financial

institutions including Reserve Bank of lndia are reduced to a per head basis, the

annual rate of increase worked out to 7.8 per cent per annum and 8.8 per cent per

annum on excluding Reserve Bank of lndia assets.

Share of Assets in Gross Domestic Product

The share of assets of all financial institutions in the Gross Domestic Product

are generally used as one of the indicators of financial development. However,

according to Goldsmith (1958), the total assets of financial intermediaries cannot be

meaningfully compared with national wealth as intermediaries' assets are gross and

unconsolidated, influenced by layering in the economy; while national wealth is a

net, consolidated notion that eliminates all creditor-debtor and holder-issuer

relationships among domestic units. Besides, a consistent valuation basis for all

balance sheet items is necessary. A comparison presupposes construction of a

national balance sheet on a consolidated basis, which is beyond the scope of this

study. It assumed that the valuation of the balance sheets of all the financial

institutions in lndia are consistent. Using the balance sheet identity that total Assets

equals total Liabilities, the total assets including Reserve Bank of lndia to Gross

Domestic Product (old) at current market prices increased substantially from 35.1

per cent in 1950 to 95.2 per cent in 1996-97 (Table IV.3). Recently, the

Government of lndia has revised the Gross Domestic Product series with the year

1993-94 as the base year. Using the linking factor of 1.0874, the new Gross

Domestic Product series was calculated. The ratio of total assets to new Gross

Domestic Product which worked out to 32.2 per cent in 1950 increased to 96.5 per

cent in 1997. With the exclusion of Reserve Bank of lndia assets, the ratio

increased from a low of 15.4 per cent in 1950 to 79.9 percent. In terms of flow, the

total assets increased from Rs.154 crore or 1.7 per cent of old Gross Domestic

248 product and 1.6 per cent of new Gross Domestic Product to Rs.1,65,286 or 14.6 per

cent and 13.4 per cent of old and new Gross Domestic Product series, respectively.

Trends In the Growth of Financial Assets

Financial assets of financial institutions have been arrived at by deducting the

tangible assets from the total. This exercise was done separately for each institution

and was later aggregated. As per the historical trends, it was observed that the

share of tangible assets to total assets was in the range of 0.25 per cent to 2 per

cent. In the case of certain institutions, it increased even to 5 to I 0 per cent, which

could be on account of increased computerisation and modernisation activities

undertaken in the early 'nineties.

The total financial assets of all financial intermediaries (including Reserve

Bank of India) in terms of stock (nominal face value) increased by 429 times from

Rs.3,058 crore in 1950 to Rs. 13,13,344 crore in 1997 representing an annual

average compound growth of 13.8 per cent.

As per the periodisation, in terms of level and average growth, the financial

assets grew to Rs.14,845 crore in 1969 at a lower rate at an annual average

compound growth of 8.7 per cent as compared with the average rate of growth for

the whole period. During the period 11 (1970-86), it increased from Rs.16,544 crore

to Rs.2.39,970 crore at the peak rate at 18.2 per cent while during period 111 (1987-

97), it grew from Rs.2,76,200 crore to Rs.13,13,344 crore at 16.9 per cent which

249 was higher the average rate of growth for the whole period (Table IV.4 and IV.5).

Thus, it can be observed that the annual average compound growth of total financial

assets of all financial institutions including Reserve Bank of lndia during the period I

(1950-69) more than doubled in the period 11 (1970-86) and marginally declined to

17.0 per cent in the period 111 (1987-97).

The total financial assets of all financial intermediaries excluding Reserve

Bank of lndia in terms of stock (nominal face value) increased by 748 times from

Rs.1,450 crore in 1950 to Rs. 10,84,635 crore in 1997 representing an annual

average compound growth of 15.1 per cent. As per the periodisation, in terms of

level and average growth, the total assets grew from Rs.1,450 in 1950 to Rs.10,179

crore in 1969 at an annual average compound growth of 10.8 per cent as compared

which was marginally higher than the growth rate when the Reserve Bank was

included. During the period 11 (1970-86), it increased from Rs.11,572 crore to

Rs.1,85,958 crore at the peak rate at 19.0 per cent while during period 111 (1987-97),

it grew from Rs.2,14,094 crore to Rs.10,84,635 crore at 17.6 per cent which was

higher the average rate of growth for the whole period (Table IV.4 and IV.5).

It can be observed that annual compound average rate of growth of total

financial assets excluding Reserve Bank of lndia assets exhibited a similar trend as

in the case of total assets including Reserve Bank of India thereby reflecting the

higher growth rate of assets of banks and non-banks as compared with those of

Reserve Bank of India.

Share of Main Types of Financial lnstitutlons In Total Financial Assets

The assets of banking system increased from Rs.1,106 crore in 1949-50 to

Rs.5,98,353 crore in 1996-97 at an annual average compound rate of 14.3 per cent,

and that of Reserve Bank of lndia increased from Rs.1,608 crore to Rs.2.28,709

crore at an annual average compound rate of 11.1 per cent, National-level term

lending financial intermediaries from Rs.l l .0 crore to Rs.1,28,729 crore at the rate

of 22.1 per cent, Investment Institutions from Rs. 248 crore to Rs.1,68,539 (14.9

per cent) and Small savings from Rs.86 crore to Rs.1,06,111 crore at the rate of

16.4 per cent during the same period. Of the Small savings, the Post Ofice Saving

Deposit rose at the rate of 10.3 per cent and that of Provident and Pension Funds

grew at 18.1 per cent per annum (Table 1V.5). It is observed that during the initial

stages of development, the share of Resewe Bank of hdia assets in the total which

was as high as 53 per cent, drastically declined by one third to 17.4 per cent.

The share of banking system in the total financial assets including Reserve

Bank of India, topped with Reserve Bank having 52.6 per cent share and banks

with 36.2 per cent in 1950. This was followed by investment institutions (8.1 per

cent), small savings (2.8 per cent) and term-lending financial Institutions (0.3 per

cent). During 1968-69, although the share of banking system declined to 68.7 per

cent due to a steep fall in the share of Reserve Bank of lndia assets from 52.6 per

cent in 1950 to 31.4 percent in the same period. The Small savings became more

attractive with its share reaching 12.8 per cent as compared with the share of

251 investment institutions at 12.2 per cent during the same period. There was also a

perceptible increase in the share of National and State-level financial institutions

(5.2 per cent) and Non-bank financial companies (1.5 per cent).

In the period II, the share of banking system in the total assets including

Reserve Bank of India, continued to top at 68.6 per cent in 1970 followed by

investment institutions (12.4 per cent), small savings (12.3 per cent) and term

lending financial Institutions (3.9 per cent). During 1985-86, although the share of

banking system increased to 71.2 per cent and the share of Reserve Bank of India

assets continued to remain constant at 22.5 per cent in the same period as in the

case of total assets of financial institutions. The Small savings became less

attractive with its share reaching 9.3 per cent along with the share of investment

institutions at 8.0 per cent during the same period. There was an increase in the

share of national and state-level financial institutions (8.9 per cent and 1.8 per cent)

and non-bank financial companies (0.5 per cent). The same trend continued in

2986-87 and during 1996-97, the share of banks topped with 45.6 per cent while

that of the Reserve Bank further declined to 17.4 per cent. The specialised

~nstitutions' share was at 1.0 per cent in 1996-97and that of mutual funds at 0.9 per

cent. With the exclusion of the Reserve Bank of India, a similar trend was observed

as in the case of total assets.

Share of Financial Assets in Gross Domestic Product

The total financial assets including Reserve Bank of lndia to Gross Domestic

Product (old) at current market prices increased substantially from 34.6 per cent in

1950 to 41.0 percent in 1969-70 and to 94.3 per cent in 1986-87 and further to

102.8 per cent in 1996-97 (Table IV.6).

Asset Profiles of Financial institutions

a) Banking System

Banking intermediaries include scheduled commercial banks, State

cooperative banks maintaining accounts with Reserve Bank of India, Non-scheduled

commercial banks and urban cooperative banks. Based on balance sheet items, the

assets of banking intermediaries have been compiled and it includes cash on hand

and balances with Reserve Bank, investments, bank credit, loan over dues and

other assets with the banking system.

The asset profile of the banking system differs from those of other financial

institutions due to statutory stipulations. Besides, their asset profiles depend upon

deposit liabilities which is largely volatile. It may be seen from Table 7, during 1949-

50, bank credit accounted for 50.5 per cent of the total bank assets followed by

investments (34.7 per cent), cash on hand and balances with Reserve Bank of lndia

(9.1 per cent) and other assets with the banking system (5.6 per cent). It is observed

that during the end of pre-nationalisation era in 1969, the share of credit increased

steadily to 71.6 per cent and reached a peak of 72.6 per cent in 1970. In the post-

253 nationalisation period, it decelerated to 56.6 per cent in 1986. However, due to the

sluggishness in industrial demand and lack of demand due to other structural

rigidities in the economy, it further declined to 52.3 per cent in 1997.

As a larger proportion of bank's investments were in the form of low yielding

Government securities, the share of investments in total bank assets declined

almost by one-third to 19.7 per cent in 1970. In pursuance of the Chakravarty

Committee Report recommendations, the yield on Government securities was

increased during the mid-eighties and subsequently with the adoption of auction

system in the Government securities market, the coupon rates were linked to the

market interest rates. The share of bank's investments picked up substantially from

27.9 per cent in 1981 to 33.9 percent in 1997 thereby indicating that investments in

Government securities and treasury bills were more attractive. Besides, this also

marks the post financial reform period, wherein the statutory reserve requirements

were reduced and auction system was introduced for Government securities.

Due to easy liquidity conditions and lower reserve requirements, the share of

cash on hand and balances with Reserve Bank of lndia too declined to 2.1 per cent.

W~th the beginning of the liberalisation phase and rationalisation of the interest rate

structure in the early 'eighties and reforms in the financial sector during the 'nineties,

the share of cash on hand and balances with Reserve Bank of lndia increased

substantially to 11.5 per cent and declined to 9.4 per cent in the same period.

Consequently, the share of other assets decreased by over 50 per cent to 2.1 per

254 cent and it increased to 4.5 per cent and marginally declined to 4.3 per cent during

the same period (Table IV.7).

b) All lndia Financial Institutions (AFls)

All lndia Financial Institutions (AFls) include lndustrial Development Bank of

India, lndustrial Credit and lnvestment Corporation of lndia (in private sector),

lndustrial Finance Corporation of India, National Housing Bank, Export Import Bank

of India, Tourism Finance Corporation of lndia and the Small Industries

Development Bank of India, Life Insurance Corporation of India, General lnsurance

Corporation of lndia and the Unit Trust of India, State financial corporations, and

State industrial development corporations. Based on balance sheet items, the

assets of all lndia financial institutions have been compiled and they are slightly

different from those of banks. These include cash on hand and balances with banks,

Investments, loans and advances, and other assets.

During 1950, in the absence of many institutions, lndustrial Finance

Corporation of lndia and a few State financial corporations, at the state-level,

dominated the institutional finance. Their asset podfolio comprised loans and

advances (48.8 per cent), investments (40.1 per cent), cash and balances with the

Reserve Bank (4.4 per cent) and other assets (6.7 per cent). Similar to banks,

during 1961, with the commencement of institutions, such as Industrial Credit and

Investment Corporation of India and Life lnsurance Corporation of India, due to

statutory stipulations, investments share topped at 63.3 per cent, loans and

255 advances accounted for 14.1 per cent followed by cash on hand and balances with

banks (7.3 per cent) and other assets (15.2 per cent). With liberalisation measures,

and pick up in demand for industrial credit, the share of loans and advances in the

asset profile of all lndia term-lending institutions, increased steadily from 30.3 per

cent in 1971 to 55.4 per cent in 1986. However, with the sluggishness in demand it

declined to 43.4 per cent in 1997. As the investments were in low yielding

Government securities, its share declined to 31.9 per cent in 1986 and consequent

to financial reforms, the proportion of investments went up to 42.2 per cent in 1997.

Due to easy liquidity conditions and reforms in the money market, the share of cash

on hand and balances with banks declined by more than half to 7.4 per cent in 1961

and it increased to 12.0 per cent in 1981 and further to 15.5 per cent in 1991 which

also marked a period of higher interest rates. The share of other assets declined to

7.8 per cent in 1981 and fluctuated to reach 4.4 per cent in 1997 (Table IV.8).

c) Mutual Funds

Mutual Funds institutions in lndia came into being only since late 1987 with

the introduction of liberalisation measures in trade and industry. Mutual funds are

essentially involved with pooling of savings of the investors and invest them as per

the objectives of the scheme. The profits are shared amongst the investors afler

meeting managerial costs. Therefore, the asset profile of mutual funds are different

from those of other financial institutions. The data are not available in a

consolidated form. Therefore, the balance sheet data for each institutions have

been aggregated to arrive the total for the industry.

256 Thus, over 90 per cent of the assets are held in the form of investments. For

the purpose of data analysis, UTI is excluded as it is treated as an investment

institution which has been established under the special Act of Parliament. The total

assets held by mutual funds institutions sponsored by banks and other public and

private financial institutions inaeased substantially from Rs.548 crore in 1988 to a

peak level of Rs. 13,090 crore in 1995 when the industry was in good shape. Due to

adverse market conditions, the total assets decreased to Rs.12,236 crore in 1997.

Of which, investments increased from Rs. 520 crore to Rs.l1,963 crore in 1995 and

declined to Rs.11,292 crore in 1997. The annual compound rate of growth in the

total assets of mutual funds institutions during the period 1988-97 at 41.2 per cent

was higher than that of investments at 40.8 per cent during the same period. Since

these are investment-oriented institutions, they do not provide loans and advances.

d) Non-banking Financial and Investment Companies

The non-banking financial and investment companies commenced their

operations in India in 1958. The data on these companies are annually published by

the Reserve Bank in its bulletin. The share of investments in the total assets of non-

banking financial and investment companies topped with 47.4 per cent in 1958 and

after reaching a high of 49.2 per cent in 1966 gradually declined to 21.7 per cent in

1986. It has shown a reversal in the trend with a marginal decrease to 13.6 per cent

in 1991 and it increased to 23.7 per cent in 1997. The loans and advances form a

major proportion of receivables for non-banking financial and investment companies

in their combined balance sheets. The share of loans and advances showed a

257 steady rise from 25.8 per cent in 1958 and reached a peak of 49.6 per cent in 1981.

It declined to 43.1 per cent in 1986 and recovered at 54.1 per cent in 1991 but

decelerated to 44.5per cent in 1997. The share of cash and bank balances

although showed fluctuations, declined from 13.1 per cent in 1958 to 2.3 percent in

1997 (Table IV.9).

Sources and Uses of Funds

Over the years, the sources and uses of funds have been generally classified

into two major groups, viz. , Internal and External. They also differ for various

institutions.

(a) Banking System

For the banking system, the sources mainly comprise, aggregate deposits.

borrowings and others which include capital and reserves. Uses comprise cash and

balances with Reselve Bank of India, investments, bank credit, assets with the

banking system and other assets. Sources and Uses for the banking system has

been compiled from the abridged batance sheet data published in the Report of

Currency and Finance by Reserve Bank of India.

It is evident from table IV.10 that as the banking system performs the function

of accepting deposits for lending, in the sources of funds, aggregate deposits

occupies a predominant position. Of the total-sources, the share of aggregate

deposits went up significantly from 55.8 per cent in 1950 to over 200 per cent in

258 1991. Other sources which include capital and reserves had a negative proportion

for most part of the decade since the mid 'seventies indicating the need for

capitalisation by Government. Borrowings also showed substantial increase over the

years which reflects that internal sources were not enough to meet the funds

requirements.

Of the total uses, bank credit occupies a major proportion of the total with its

share at over 100 per cent in 1950. The share of investments was negative at 27.9

per cent. Over the years the share of bank credit has declined by one half to 50.1

per cent in 1981 and that of investments have increased to 31.6 per cent. Cash plus

balances with Reserve Bank of lndia showed a higher proportion of 8.0 per cent in

1951 and it declined to a negative of 6.6 per cent in 1997. Assets with the banking

system showed fluctuations (Table IV.lO).

(b) All lndia Financial Institutions (AFls)

Sources of funds of financial institutions fall primarily into two broad

categories viz., internal and external, Internal sources of funds relate to increase in

capital and reserves, salelredemption of past investments, repayments of past

borrowings, dividend and interests on investments. External sources, on the other

hand, arise primarily from fresh borrowings (both Rupee and foreign currency) from

the market, borrowings by way of bonds and debentures, etC.

259 Under Uses of funds, Internal funds comprise of fresh disbursements and

investment in shares" debentures etc., such as, new loans and advances

investments etc. The external Uses of funds constitute repayment of past

borrowings which indude redemption of bondsldebentures issued in the past

repayment of Rupee and foreign currency loans etc.

The data on sources and uses of funds for all India (tern? lending) financial

institutions are available since 'seventies. An analysis of data reveals that while

external sources of funds constituted 54.2 per cent in 1971, external uses of funds

constituted 64.9 per cent thereby indicating that over 50 per cent of the external

funds came from internal sources. However, during the subsequent years, the

contribution from internal sources for external uses declined to 30.3 per cent in

1975-76 and it increased to 58.9 per cent in 1986 thereby reflecting the pickup in

industrial credit and increased industrial activity. It is to be noted that the

rationalisation of industrial licensing policy received a sharper focus since 1975. The

trend got reversed since 1986 with the decline in the share of external uses and the

increase in the uses of internal funds. It also implies that lending to external

purposes resulted in higher returns.

Of the total sources, external source constituted the major source of funds till

1980-81 and therefrom it declined gradually to 54.1 per cent in 1981 to 35.3 percent

in 1995. Internal sources showed an increase from 55.2 per cent in 1991 to 64.7

Percent in 1995 reflecting cheaper funds were available internally. It may also be

260 seen that on the Uses side, external uses constituted a major proportion of the total

throughout the period ending 1995. Since the 'eighties' a higher proportion of

internal funds were used for external purposes (Table IV.ll).

(c) Non-banking Financial and investment companies

The sources and uses of funds of non-banking financial and investment

companies are slightly different from those of term lending financial institutions. As

the non-banking financial and investment companies are not allowed to borrow in

foreign currency, their internal sources of funds compromise paid-up capital,

reserves and surplus and provisions. The External sources consists of new issues of

paid-up capital, borrowings and others. Under Uses of funds, Internal funds

comprise investments and cash on hand and balances with banks. External uses of

funds constitute receivables and others.

An analysis of data reveals that during their initial stages of inception, more

than 100 per cent of their sources of funds were used for external purposes in 1957-

58. During 1960-61, 13.5 per cent of their external sources of funds were used for

internal purposes. The trend got reversed during 1965-66 and 1980-81 with 3.0 per

cent and 8.2 per cent of external sources of funds were used for internal purposes,

respectively. During 1970-71, 10.5 per cent of the internal sources of funds were

used for external purposes. Similarly, during 1975-76 and 1985-86 about 30 per

cent and 4.0 per cent of internal sources of funds were utilised for external

Purposes. During the 'nineties, the share of external sources of funds was larger

261 than the internal sources and surplus was there after meeting external uses for

internal purposes (Table IV.12)

Analysis of Income and Expenditure

(a) Banks

The analysis of income and expenditure covers only scheduled commercial

banks as the data for co-operative banks and non-scheduled commercial banks are

not readily available in published form. Only in the recent period data is published in

the Report on Trend and Progress of Banking in India, 1998-99. It may been seen

from the Table IV.13 that the total income of scheduled commercial banks increased

at a compound average rate of 17.5 per cent during 1951 to 1997 while the

expenditure grew at the rate of 18.3 per cent. The return on investments increased

at a slower pace from 2.6 per cent in 1951 to 4.5 percent in 1980 and declined to

3.7 per cent in 1985. The return on loans steadily increased from 4.5 per cent in

1951 to 12.1 percent in 1985. The cost of deposits from a low of 0.9 per cent

;.lcreased 6 times to 6.1 per cent during the same period. This reflects the steady

fall in profitability of the banking system. Prior to nationalization of banks in 1969,

administered system of interest rates prevailed since 1964 with the R e s e ~ e Bank

prescribing the ceiling rates on deposits and advances. Progress in banking

business was also slow.

During the period 1951 to 1969, the State Bank and its associates

representing the public sector accounted for about one-third of the banking industry.

262 Of the total 81 banks, about 23 were either liquidated, amalgamated or merged with

other scheduled banks thereby reducing the total number of banks to 58. The

average population per bank branch, which was high at 1,32,700 in 1950 dedined

after nationalization to 64,000 in 1969. It further dedined to 15,000 in 1986-87 being

the early stage of liberalisation and reform period. After nationalisation, banks had

to invest a major proportion in Government securities, and consequently, the return

on investments were low on account of low yields on Government securities. In the

area of credit, their portfolio consisted of large number of priority sector credit where

the recovery was poor. However, during the 'nineties, the position improved

substantially on account of banking and financial sector reforms.

(b) All lndia Financial Institutions

Data on income and expenditure of all financial institutions were not available

in published form for the earlier years. During the period 1957-58 to 1965-66 data

pertains only to Industrial Financial Corporation and State Financial Corporations.

For the remaining period, the data have been consolidated for All lndia Financial

Institutions (AIFls), which were published in the Report on Development Banking in

lndia by IDBI. The total income of the financial institutions witnessed a significant

increase over the period 1995-96 to 1997-99 (Table IV.14).

The ratio of assets to income showed a significant increase from 4.6 to 9.1 in

1966 but declined to 5.9 in 1999. The return on investments doubled from 21.4 to

43.6 in 1961 and since then declined to 9.3 in 1998 and recovered to 10.5 in 1999.

Return on loans showed a steady increase from 2.5 in 1958 to 7.9 in 1996 and

263 thereafter showed marginal decline. The cost of borrowings also showed a.

substantial decline from as high as 333.5 in 1958 to 22.5 in 1966 and to 4.5 in 1999.

The cost of funds since 1996 showed a decline from 23.0 per cent to 8.0 per cent in

1999 reflective of interest rate rationalisation and reforms undertaken

(c) Non-banking Financial and investment companies

In the case of non-banking financial and investment companies, income from

main operations accounted for around 85 per cent of total income except for the

years 1971, 1976, and 1995. The main income-generating activities in the order of

importance were lease, hire purchase, merchant banking, bills discounting and trade

finance.

The main constituents of expenditure (before gross profits) in the order of

importance have been finance expenses, administrative charges and establishment

charges. Interest payments accounted for the bulk of expenditure which increased

from 16.2 per cent in 1958 to 44.6 percent in 1997. In terms of quantum, it

increased from Rs.0.89 crore in 1958 to Rs.2428 crore in 1997 at an annual

average rate of 22 .O per cent. This is indicative of improved financial management

and the impact of the rationalisation in the structure of interest rates. In 1995, there

was an acceleration in interest payments which is reflective of higher costs of

resources (Table IV. 15).

264 The return on investments increased although showed fluctuations, increased

from 10.1 per cent in 1958 to 11.9 percent in 1961 but decelerated to 8.7 per cent in

1981 and after oscillating increased to 13.7 in 1997. Return on loans showed a

better picture with an increase from 22.3 per cent in 1958 to 33.8 percent in 1986

and thereafter showed deceleration. A similar trend was observed with regard to

cost of funds.

An Analysis of Factors Determining Investments and Credit

From the above analysis, it is evident that in the financial development

process, India followed a multi agency system to foster economic growth. If we look

at the asset composition of all the institutions, it is evident that investments and

credit are the two important financial assets in terms of their share in the total and

Gross Domestic Product. Therefore, we confine to these two indicators.

Management of assets refers to allocation of available funds to various purposes, be

it for investments or for credit. While most decisions on asset allocations are based

on future availability of funds, macroeconomic policy play a significant role. The

monetary policy primarily aim to control inflationary impacts and thereby control

liquidity in the economy, the fiscal policy serves as a tool to achieve the national

objectives of growth, equity with social justice. The banking system, being a

Principal source of liquidity, meets their liquidity needs through their deposit

mobilisation. The financial institutions meet their needs by term lending operations,

borrowing from the central bank, and to a limited extent through public deposits. The

mutual fund institutions, primarily being an investment institutions, pool savings from

265 the public and invest them mostly in the primary segment of the capital and money

markets. The Non-Banking Investment and Finance Companies, too pool savings

of the public and lend the same or invest them for various activities. Thus, only

commercial banks have the ability to create credit by several folds as compared with

other institutions. If increase in credit is matched by economic growth, then it does

not pose any problems to the monetary authorities. Contrary-wise, it would lead to a

rapid expansion in the reserve money, which poses the problem of controlling the

growth in the money supply and maintaining economic and financial stability. The

Reserve Bank, therefore controls the liquidity in the financial system through various

methods such as the bank rate, cash reserve ratio, statutory liquidity ratio, repos etc.

Statutorily, banks and financial institutions are required to invest in Government and

other approved securities. Banks are also required to lend a certain proportion of

their deposits to the priority sectors and the financial institutions are required to

invest a certain proportion of their total resources in the socially oriented purposes.

Consequently, the bank's ability to create credit and financial institution's ability to

invest funds for other purposes gets reduced, thereby the liquidity in the financial

system is regulated. Thus, in India, the availability of funds for various purposes is

more important than the cost of funds.

For the purpose of making a comparative analysis of various institutions and

to empirically analyse the determinants of two key variables, viz., investments and

credit ordinary least square technique was employed.

266 Based on the trends, economic relationships and earlier studies (Banking

Commission, 1970), the study specifies the following factors for investment and

credit to find out their influence on them for different institutions. These include,

lndex of Industrial production (IIP), ratio of investment to total assets (RITA) for the

respective institutions, Call money rates (CALL), lndex of Agricultural Production

(IAP), Weighted Average yield on Government Securities (WGS). Additional

variables such as, Cash Reserve Ratio (CRR), Weighted Average Lending Rates

(WTLR) and Weighted Average Deposit Rates (WTDR), Statutory Liquidity Ratio

(SLR), ratio of credit to total assets (RCTA) for the respective institutions, and

variable dividend rates on Industrial shares were also used.

The results of the determinants of Investment and credit are presented in

Tables IV.16, IV.17 and IV.18. The positive and statistically significant determinants

of Total credit of all financial institutions, credit of AN lndia Financial Institutions,

bank credit and non-bank credit include, lndex of Industrial Production and ratio of

investment to total assets (except for credit of All lndia Financial Institutions). The

Call money rates and lndex of Agricultural Production had a positive and significant

influence on non-banks. Weighted Average yield on Government Securities was

found to be negatively and significantly related to Total credit of all financial

institutions, credit of All lndia Financial Institutions, bank credit, and lndex of

Agricultural Production with Total credit of all financial institutions and bank credit.

Additional variables such as, Cash Reserve Ratio, Weighted Average Lending

Rates and Weighted Average Deposit Rates was found to be negatively and

significantly related to bank credit. The factors that did not satisfy the theoretical

267

expectations include, (i) ratio of investment to total assets for Total credit of all

financial institutions, bank credit and non-bank credit, (ii) lndex of Agricultural

Production for non-bank credit.

In the case of investment, the positive and significant determinants are, (i)

lndex of lndustrial Production for total financial institutions, All lndia Financial

Institutions and banks, (ii) ratio of credit to total assets and Weighted Average

Lending Rates for non-banks, and (iii) Weighted Average yield on Government

Securities for Mutual Fund Institutions. The factors that negatively and significantly

influenced were, (i) Weighted Average yield on Government Securities for total

financial institutions, AN lndia Financial Institutions and banks, (ii) Weighted Average

Lending Rates for total financial institutions, All lndia Financial lnstitutions and

Mutual Fund Institutions. Additionally, negative influence was noticed in respect of,

(i) Call money rates, Statutory Liquidity Ratio, ratio of credit to total assets for banks;

(ii) variable dividend rates on Industrial shares for non-banks and Mutual Fund

Institutions; and (iii) Weighted Average Deposit Rates and lndex of lndustrial

Production for non-banks. Theoretical expectation was not satisfied in the case of,

(i) Weighted Average yield on Government Securities for total financial institutions,

All lndia Financial lnstitutions and banks; (ii) variable dividend rates on lndustrial

shares for non-banks and Mutual Fund Institutions; (iii) Call money rates for banks;

(iv) Weighted Average Lending Rates, ratio of credit to total assets and lndex of

lndustrial Production for non-banks. In order to identify the strudural breaks, the

regression was nm separately for total credit and total investments for the three

268 periods, Vtz., (i) 1950-69, (ii) 1970-86 and (iii) 1987-97. The results were robust

and coincided with economic theory.

Summary and Conclusion

This Chapter analyses the operations of different financial institutions in India.

It shows that lndia has been following a multi agency system to cater to the financial

needs of different segments of the economy. It has been observed that the banking

system dominated the financial system. However, in the later years, with the

transformation of the financial system into a more sophisticated modern one, the

non-banks play an increasing role. It has also been observed that given the same

regulatory and macroeconomic environment, there are differences within the same

group of institutions as well as among various other institutions. Hence, comparative

analysis of the operations of financial institution will provide rich insights into their

workings and problems. In the light of this experience, setting up of newer

institutions in future would go a long way in helping these segments of society with

better financial infrastructure, which would enhance growth.

An analysis of the data shows that although lndia is endowed with a variety of

financial institutions, each having a different purpose, these became operational at

different points of time thereby changing the financial structure. Secondly, the

growth of different financial intermediaries have been uneven. Given the same

financial environment, the different types of institution have performed differently. An

exercise was also done to study the factors affecting investments and credit of

269 various institutions. The results showed that several factors had a positive as well

as negative and significant influence on credit and investments of various institution.

The policy variables such as Cash Reserve Ratio and Statutory Lending Ratio had

significant impact on the banking institutions. Interest rate variables also influenced

other institutions as well. These were as per theoretical expectations. The structural

breaks on account of financial liberalisation, deregulation and reforms were evident

during the three periods.

Table IV.l: Trends in Growth of Total Assets of Financial institutions

Igures in round brackets and square indicate percentage to total assets ~ncludlng and exclud~ng Reserve Bank of India, respectively.

Investment Institutions

Seciaiised Institutions

[O.O) 250

(8.1) [ I691

0

[2.0] 1832

(12.3) [17.9]

0

(2 1) 2079

(12.5) [17.8]

0

12.4) 19641

(8 1) [10.4]

0

[2.5) 22937

(8.2) [10.6]

0

123) 58151 (104) [13.11 5309

12.0) 170459

(12.7) [ I541 13851

Table IV.4: Trends in Growth of Financial Assets of Financial institutions

excluding Reserve Bank of Ind~a, respectively.

273

Table IV.5: Trends in Compound Growth Rates of Financial Assets of Financial institution

Table IV. 6: Total Financial Assets of Financial Institutions: Share in Gross Domestic Product

Table IV.8: Asset Profile of All India Financial Institutions

(15.50)l (32.40)( (51.20)l (0.90) (100.00) 1997

Note: Figures in brackets indicate percentage to total.

35467 149612 (10.00) (42.18)

154036 (43.43)

15557 (4.39)

354672 (100.00)

Table IV.lO: Sources and Uses of Funds : Banking System (Rs.crore)

11950-51 1 1955-56 11960-61 1 1965-661 1970-71 / 1975-76 1 1980-81 1 1985-86 1 1990-91 1 1996-97 1 2 1 3 4 1 5 1 6 / 7 8 9 1 1 0 1 1 1

Sources

Note: Figures in brackets indicate percentage to total.

Table IV. l l : Sources and Uses of Funds : All India Term-Lending Institutions

Note. F~gures In brackets indicate percentage to total.

Table IV.12: Sources and Uses of Non-Banking Financial and Investment Companies

Table IV.13: Income and Expenses of Scheduled Commercial Banks

Table IV.16Regression Results-Dependent Variable: Investment (1950-1997)

fi Table IV.@ Regression Results- Dependent Variable: Credit (1950-1997)

Variables Dependent Variables

RITA 858.1

(7.83)

SEE 6138 1.06 160.13 65.85

N a ' . ?-\'Gu %o~-r 't' V U L ~ x L\d,\,~U-K.t ~ l c k \~.u-c \*,PC CP-%+ kui

Share Price

WTGS

WTLR

WTDR

CALL

I AP

IIP 2295.5 1723.7 701.0 0.2

0.1

( g 3 1 -0,001 (-0.27)

-0.01 (-0.46)

2.1 (1.08)

0.5 (3.38Y

0.28 (2.34P

907.2 -565.2 j -1929.8 - (0.26) 1 (-027) , (-1.47)

-12877.0 (-3.74)'

-3675.6 (-1.36)

-1 197.9 (-0.92) -303.8 (-0.26) -904.6 (-2.02).*-

-7099.2 (-3.27y

-2891.3 (-1.95)

-1.5 (-1.84) 546.7 (0.78) -475.6 (-1.84)

-3924.8 (-2.60y

-1 310.4 -- (-1.29) -540.1 ( 1.04) -456.0 (-1.03) -161.9 (-0.62)

\e Table IV.6 Regression Results- structural Breaks during (1950.1997)