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Introduction

Both India and China have introduced significant financial sector reforms with a view to improvingefficiency and enhancing stability of their financial systems. This report attempts a comparative study of financial systems in India and China, especially in the context of the financial sector reforms and identifiesthe challenges ahead. The study finds that although the financial systems in both the countries continue to bedominated by the public sector banks, there were significant differences in the initial conditions. At the timeof initiation of reforms, while India had a reasonably well developed financial system, China had to start

virtually from nothing. Not surprisingly, the nature of financial sector reforms undertaken in the twocountries has been different in many respects. Initiation of various financial sector reforms has helped overthe years in making the Indian financial system quite robust. The financial system of China has alsowitnessed some improvement, although several challenges remain. The future challenge for the Chineseauthorities is to strengthen the banking system and further reform the capital market. The major challengefor the Indian financial system is to bring down the intermediation cost of the banking system.

The financial system plays an important role in promoting economic growth not only by channelling savingsinto investments but also by improving allocative efficiency of resources. The recent empirical evidence, infact, suggests that financial system contributes to economic growth more by improving the allocativeefficiency of resources than by channelling of resources from savers to investors. An efficient financial

system is now regarded as a necessary pre-condition for growth. This shift in the emphasis along withopening up of domestic economies to international competition has encouraged emerging market economies(EMEs) such as India and China to introduce financial sector reforms. It is now widely recognised thatstability of the financial system is critical for a sustainable growth. China has been growing rapidly eversince it introduced structural reforms in 1978. With the real per capita income rising over five fold, Chinahas been able to get over 200 million people out of poverty (Tseng, 2007).

While China‘s macroeconomic performance has been quite robust, its financial system has accumulated non-performing loans (NPLs) to a considerable extent. The macroeconomic performance of India has alsoimproved significantly in the post-reform period. The Indian economy has become quite resilient over theyears. Importantly, India‘s improved macroeconomic performance has been associated with a significant

improvement in its financial system.

Emerging markets like India have exhibited a strong growth momentum, driven by a robust demand,

consumption and savings rate. A study by World Bank supports this by forecasting that the share of the five

big emerging economies India, China, Indonesia, Brazil and Russia in 2020 will double to 16.1% from 7.8%

in 1992.

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Indian financial system

The Indian financial system is reasonably well developed with both the banking system and thecapital market which playing an important roles.

There has been significant improvement in the profitability of the banking system.

The capital market in India has also undergone the changes in the recent past and is now comparable tothe best in the world.

There are significant differences in the financial system of India and China. The Indian financial system isreasonably well developed with both the banking system and the capital market playing important roles,even as the financial system is dominated by the banking system. There has been significant improvement inthe profitability of the banking system as a result of which the financial system, on the whole, has becomerelatively safe, sound and efficient. The capital market in India has also undergone the changes in the recentpast and is now comparable to the best in the world.

India has been one of the best performers in the world economy in recent years, but rapidly rising inflationand the complexities of running the world's biggest democracy are proving challenging.

India's economy has been one of the stars of global economics in recent years, growing 9.2% in 2007 and9.6% in 2006. Growth had been supported by markets reforms, huge inflows of FDI, rising foreign exchangereserves, both an IT and real estate boom, and a flourishing capital market. Like most of the world, however,India is facing testing economic times in 2008. The Reserve Bank of India had set an inflation target of 4%,but by the middle of the year it was running at 11%, the highest level seen for a decade. The rising costs of oil, food and the resources needed for India's construction boom are all playing a part.

The report mentions the challenges faced by the banking industry, most importantly that of enhancing

inclusive growth. ―Only 37% of bank branches of Scheduled Commercial Banks are present in rural areas,

with only around 40% of the population holding a bank account. Moreover, out of the 600,000 villages in the

country, only about 30,000 have a commercial bank branch.‖ Promoting financial liter acy, re-structuring of 

MFIs, support of technology, simple product offerings and regulating the self-help groups, are some of the

steps that have been suggested to help increase the reach of banking services.

"Infrastructure financing has been featured in the report as a key pillar of growth, with banking sector havingan increasing role to lend further momentum to this sector. The report lays emphasis on the role of the

private sector towards funding infrastructure development, apart from strengthening the corporate bond

market and increased participation from pension funds and insurance companies," PwC says.

The Indian capital market giving a snapshot of the current state of each segment of the capital market. The

report highlights the fact that ―with a population of more than a billion, a mere 1% of the population

 participates in capital markets, and of that only a fraction is active.‖ 

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―A huge challenge for financial institutions today is functioning and retaining their efficiency in such

uncertain times. Business models are undergoing a structural change to accommodate the changing

regulations and foster growth. There needs to be a well-defined framework which will withstand disruptions

and lead the financial markets towards growth and progression.‖

China’s financial system

•  Several improvements have also taken place in the financial system of China. The level of NPAsover the years has declined significantly.

•  The intermediation cost in China has also declined quite significantly.•  The capital market in China has grown rapidly.•  The Chinese financial market is still lacking in product varieties. Financial deepening is still

inadequate and there are hardly any innovations

Several improvements have also taken place in the financial system of China. The level of NPAs over theyears has declined significantly, even as it continues to be large by international standards. The

intermediation cost in China has also declined quite significantly. The capital market in China has grownrapidly. Empirical evidence also suggests that firms‘ stock prices do reflect their fundamentals to asignificant extent indicating that stock prices play a role in giving information about issuers‘ fundamentals.Notwithstanding several initiatives by the Chinese authorities to reform the financial system, there areseveral areas which merit attention. The banking system continues to be characterised by largenonperforming loans.

· Financial intermediation in China continues to be largely bank-based with the capital market playing only aperipheral role in the financial system. The share of capital market funding remains small in comparisonwith that in developed economies. In the first half of 2007, bank deposits constituted the largest source of funding (83 per cent) cornon-financial sector (including households, enterprises and government), followed

by treasury bonds (12 per cent), stocks (4.6 per cent) and company bonds (0.4 per cent)( Li Wei, 2007).There is evidence to suggest the prevalence of excess capacity build-up in several manufacturing industriesand real estate. One of the major reasons for this has been the large proportion of lending to the SOEs.

The Chinese financial market is still lacking in product varieties. Financial deepening is still inadequate andthere are hardly any innovations (Xiaochuan2007)

·  China‘s monetary system is still dominated by direct control measures in the form of credit and interest rateceiling and reserve requirements.

· The size of the primary capital market is small with limited number of new issuances of debt and equity.Also, the majority of shares (accounting for about two-third of stock market capitalisation) are not traded. Itneeds to be noted that unlike in India, reforms in the real sector in China preceded reforms in the financialsector.

· In comparison with the agricultural and industrial reforms, the reforms in the financial sector in Chinamoved at a slow pace. It was perhaps due to this reason that the financial sector remains vulnerable. In India,on the other hand, financial sector reforms started early in the reform cycle which imparted in a significantway efficiency and stability to the financial sector (Reddy, 2003). The faster reforms in the other sectors of the economy call for quick reforms in the financial sector in China.

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Financial Intermediaries in China(As at end-December 2007)

Category Assets % of Total Assets

1. Commercial Banks (i to iv) 20,511 74.2

i) State-owned commercial banks 15,194 55.0ii) Joint-stock commercial banks 3,817 13.8iii) City commercial banks 1,462 5.3iv) Rural commercial banks 38 0.1

2. Co-operative Banks (v+vi) 2,798 10.1v) Urban credit cooperatives 147 0.5vi) Rural credit cooperatives 2,651 9.63. Policy Banks 2,125 7.7

4. Other institutions (vii to ix) 2,205 8.0

vii) NBFIs 910 3.3viii) Postal Savings 898 3.3ix) Foreign funded FIs 397 1.4Total (1 to 4) 27,639 100.0

Source : China Banking Regulatory Commission (www.cbrc.gov.cn)

This table indicate about the financial intermediaries in China which was of the year 2007. And on that thefirst is the Commercial Bank which asset were about 20,511 and which account for total assets was 74% andin that the State- owned commercial bank, Joint stock commercial bank, City commercial and ruralcommercial bank. While the second is the Co- Operative Bank which was about nearly 2800 assets andwhich account for total assets was 10% and in that include the urban credit cooperatives and rural creditcooperatives. Then third is the Policy Banks which include about 2125 total assets and which account for7.7% of total assets. And the fourth is the other institution which about 2200 assets and which account for8%, and which include NBFIs, Postal Savings and Foreign Funded FIs.

Future of India and China

Nobody can afford to ignore India and China these days: certainly not the CEOs of multinationals seeking toeither leverage low-cost and increasingly skilled workforces or gain access for their products or services tothe world‘s largest and fastest-growing developing markets; not the US government, when China holds morethan $1 trillion in treasuries and other foreign currency reserves; Western consumers who are having to cut

 back on cheap imported goods while at the same time worrying whether their jobs might be ―offshored‖ toIndia or another low cost center.

Even without these credit crunch-driven concerns, the rapid rise of these two new economic superpowers,who‘s combined population of 2.4 billion represent 40% of humanity, compels attention. For what is

happening is a huge shift of economic gravity from West to East. Or, if you take the extremely long view, areturn to the global balance of 200 years ago, when China and India between them accounted for roughlyhalf of the world‘s economic activity. 

If projections based on recent annual growth rates of around 11% for China and 9% for India hold good,then these two countries will generate half of global GDP by 2050. By that time China will be the world‘slargest economy, with the US relegated to second place, followed closely by India. The two Asian giantswill between them consume the lion‘s share of the world‘s additional energy production. And unless there is

a radical move away from their dependence on coal combined with an introduction of clean technologies,they will become the world‘s largest emitters of greenhouse gases. 

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How much credit crunch affect to India and China

Those projections depend on a number of assumptions, the most crucial being the depth and extent of thecurrent recession and whether recent momentum toward free trade and globalization continues. Until quiterecently there was a strong body of opinion that the credit crunch and any resulting downturn would be

restricted to the United States and other advanced economies while China, India and the other developingeconomies would motor onward. Their economies, it was argued, had ―decoupled.‖ That was before thisspring‘s sell-off in Asian markets, which saw the Shanghai Composite index tumble by 43% — admittedlyfrom high valuations of an average price/earnings ratio of around 50 times earnings —while Bombay‘sSensex dropped by nearly a third.

While Villamin is unimpressed by arguments about the decoupling of emerging economies, he does notforesee the US slowdown causing a financial Armageddon. ―It will be felt in the emerging world,‖ he says,―but that need not translate into outright recession in either China or India.‖ Rather, on the basis of the US

economy achieving a modest 1% GDP growth this year, he sees China‘s growth rate slowing from 11.5% in2007to a still respectable 9.8% this year and 9.3% in 2009.

Similarly, India‘s growth rate is forecast to slip from 8.7% to 7.8% in 2008 before picking up again to 8.3%next year. The difference, Villamin explains, is because ―with India the trade account is not so important adriver of the economy.‖ As a result, he sees China as being ―more exposed to the global credit crunch.

Apart from the fallout from a slowdown in global trade, future growth prospects will depend very much onhow far the two countries‘ governments and central banks are willing to go to curb rising inflation. Again,China, with inflation currently running at 8.7%, seems to be facing the tougher challenge, and premier Wen

Jiao Bao has declared this a priority. However, both countries are faced with sharply higher commoditiesprices on international markets — especially the recent surge in rice, which recently hit a 34-year record.

China‘s top-down decision-making structure may be better placed to cope with this particular challenge. Itscentral bank is expected to attack inflation by freezing interest rates, tightening money supply and allowingthe renminbi‘s 6.7% appreciation so far against the US dollar (in which most commodities are priced) tocontinue.

Yet ―one of the challenges that India faces in a world of sharply rising commodity prices,‖ observesVillamin, is that ―as a fairly closed economy it continues to subsidize fuel and agricultural goods at priceswhich are well below those of the global market.

And India‘s democratically elected coalition government has nowhere liked the same leeway that theChinese leadership has in imposing radical policy shifts from above. The inability of the government inDelhi to push through major infrastructure projects in the face of local interests, state governments and anindependent but slow-moving judiciary that is capable of defending individuals‘ rights may frustrate centralpolicymakers and foreign investors alike, but at least it represents a system of checks and balances that isabsent in China.

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Competition between India and China

The two Asian giants as ―inverted images of each other,‖ arguing that ―what China is good at, India is not.‖The absence of overriding central authority in India may explain why ―China can build cities overnightwhile Indians have trouble building roads.‖ And the fact that each country has developed quite separatestrengths —China as the world‘s factory and India as its back office— did not occur because policymakerssigned up to a non-compete clause but because each is ―hard-wired‖ to excel in different fields. For instance,many Indians‘ facility with English and ―soft skills‖ make them supremely adapted to IT programming andstaffing call centers, but the country‘s inadequate transport infrastructure inhibits their competing in finished

goods as the Chinese do. The opposite is true of China. As Villamin points out: ―Actual production costs inIndia are quite low, and on that basis alone it could be competitive in supplying finished manufactured goodssuch as motorcycles.

That may explain why, until recently, both India and China have focused on selling their goods and servicesto the developed world rather than to each other. Bilateral trade has grown from just $5 billion in 2003 toaround $38 billion over the past five years. But that is small change compared to their exports to the US,Europe and other developed countries.

Moreover, further growth in bilateral trade, expected to reach $60 billion by 2010, is likely to raise tensions between the two countries. The trade balance is skewed heavily in China‘s favor, the surplus rising from $4billion to $9 billion last year, with Indian businessmen complaining that the renminbi‘s link to the decliningUS dollar gives Chinese exporters an unfair advantage. Add to that the fact that China‘s exports are mainlymanufactured goods, while bulk commodities such as iron ore still make up a large part of India‘s trade withChina,

So it is hardly surprising that, during his recent visit to Beijing, Indian Prime Minister Mr. Manmohan Singhcalled for the dismantling of non-tariff barriers and tougher action protecting IT and other intellectualproperty rights.

The rivalry now extends to the Indian Ocean, with Delhi ―pursuing defense and commercial engagement

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with countries such as the Seychelles, Mauritius and Mozambique in order to counter Chineseexpansionism,‖ according to a recent report by Chatham House, the London-based think tank, which pointsout that ―most of India‘s trade and 89% of its oil arrives by sea, so keepin g shipping lanes safe is a strategic

 priority.‖ 

So which of the two, the elephant or the dragon, is set to achieve global dominance? As things stand, most of the money is backing China, though a question mark remains as to whether it can continue to combine

market-driven growth with a system of ―social stability‖ built around the absence of democratic freedomsand property rights over the long term. As for India, it has been slower off the blocks and certainly needs afirmer sense of direction. But it is more likely to stay the course.

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Recent Growth Trends in Indian Economy

India's Economy has grown by more than 9% for three years running, and has seen a decade of 7%+ growth.This has reduced poverty by 10%, but with 60% of India's 1.1 billion population living off agriculture andwith droughts and floods increasing, poverty alleviation is still a major challenge.

The structural transformation that has been adopted by the national government in recent times has reducedgrowth constraints and contributed greatly to the overall growth and prosperity of the country. However

there are still major issues around federal vs. state bureaucracy, corruption and tariffs that requireaddressing. India's public debt is 58% of GDP according to the CIA World Fact book, and this representsanother challenge. During this period of stable growth, the performance of the Indian service sector has beenparticularly significant. The growth rate of the service sector was 11.18% in 2007 and now contributes 53%of GDP. The industrial sector grew 10.63% in the same period and is now 29% of GDP. Agriculture is 17%of the Indian economy.

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Growth in the manufacturing sector has also complemented the country's excellent growth momentum. Thegrowth rate of the manufacturing sector rose steadily from 8.98% in 2005, to 12% in 2006. The storage and

communication sector also registered a significant growth rate of 16.64% in the same year. Additionalfactors that have contributed to this robust environment are sustained in investment and high savings rates.As far as the percentage of gross capital formation in GDP is concerned, there has been a significant risefrom 22.8% in the fiscal year 2001, to 35.9% in the fiscal year 2006. Further, the gross rate of savings as aproportion to GDP registered solid growth from 23.5% to 34.8% for the same period.

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US Financial Crisis: Effect on Indian Corporate 

The collapse of the USA financial markets has unleashed a wave of uncertainty, India don't know whichbank or financial institution or mutual fund or insurance company might announce bankruptcy.

For the Indian markets, this crisis of confidence is huge. They are still trying to ascertain the damage andlike the rest of the world, do not know what more lies ahead. The day the news broke, there was a virtualmeltdown across the board but the maximum brunt was borne by the banking, finance or NBFC stocks,

realty and IT stocks. It was too early for the banks to come forth and state their damage but the marketsknew that it would be substantial.

Effect on Indian Banks 

The worst affected is the private sector bank, ICICI Bank, its exposure is to the tune of $80 million, which itinvested in Lehman's senior bonds. The bank has issued a statement saying that it had already madeprovisions of $12 million on these bonds and a further $28 million worth of provisioning might be requiredif 50% recovery is assumed. SBI has an exposure of around $55 million (Rs256 crore) and PNB $5 millionto Lehman. Bank of Baroda's exposure is less than $10 million.

Effect on Realty/Infra Projects 

Lehman and Merrill have invested through FDIs in many projects in India, in realty and infrastructure.Those projects which have received the full amount earmarked for the project are safe. But what about those,who are yet to get the promised funds? Surely their projects lay in a lurch today. Unitech has also gone onrecord stating that it has received Rs.740 crore and has closed the deal with Lehman Brothers. DLF Assetsraised US$200 million in 2007 as equity from Lehman Brothers, the company says that the money has beenreceived but equity is yet to be transferred.

Lehman had also invested $80 million in Bangalore-based SEZ Gandhi City and was likely to hike its shareto $300 million. Ashok Piramal's Peninsula Land has inked a JV with Lehman, which will have a stake of 

75% is to bring in Rs.5 billion, to invest in various realty projects of Peninsula.

Lehman has a 28.41% stake in KSK Energy. The above shares are locked in for a period of one year fromJuly 05, 2008 (the date of IPO allotment) and cannot be sold in the stock market till the expiry of the saidperiod.

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Effect on Pre-IPO Placements 

Apart from the projects, the biggest threat is for projects which currently seeking pre-IPO placements. Witha fear psychosis gripping all, and FIIs yet to ascertain the losses on which they are sitting on, it is going tobecome difficult for companies, vying to set up mega projects but seeking pre-IPO placements with reputedFIIs. Lack of any takers for pre-IPO stakes would mean delays. Yes, there will be other investors who wouldbe willing to buy stakes but would now expect it at far below the prevailing market rates. But will that againbe economically viable?

Adani Power is currently looking at placing 4.4-5% stake of its equity with private equity investors. JetAirways had planned to raise $400 million from private placement with institutions. ICICI Securitiesplanned to offload 15% of its stake to raise $1 billion. Morgan Stanley Private Equity is to pick up a 30.4%stake in Biotor Industries for Rs.240 crore ($53 million). Will that happen now? Tata's Ginger Hotel chainplanned to offload 20% of its stake to raise $75-100 million for expansion of its no-frills hotel chain Ginger.Retail chain group  – Subhiksha which also nurtures plans of going public is seeking FII investment for its9% stake and was hoping to raise $80-100 million (Rs.400 crore).

AIG might have been pulled back from the brink of bankruptcy but it indicates the deep rooted trouble in the

US financial markets. The collapse of Lehman and Merrill is sure to have far reaching consequences inIndia. It can only hope that this is the end of the dark tunnel though the road to light is dark, long andwinding.

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Major Challenges faced by the Financial Sector in ChinaAs part of its accession to the WTO, China has promised to open banking business in all places and in allcurrencies to foreign banks by2006. After December 2006, foreign and domestic banks should be able toProvide products to all customers in China throughout the country. With this, the banking system in Chinawill face serious challenges;

1)  There is a large stock of NPLs in comparison with the international standards.2)  There is still a gap between the management and operational capacity of the wholly state-owned

commercial banks and that of the world's leading banks.3)  The regulatory and supervisory system is not yet prepared for the complexities of the new situation.

The key focus of further reforms in the Chinese financial system is on resolution of NPLs problem. Thisrequires concrete action plan on two fronts , i.e, to resolve the existing stock of NPLs and to avoidaccumulation of further NPLs. Ceiling on interest rates as and when removed could also allow banks to pricetheir products based on their risk-return perception. To overcome the stock problem, the authorities need tokeep in view the experience of the four AMCs set up, which has not been satisfactory as their losses areexpected to surpass the current financial contributions to the AMCs from both the Ministry of Finance andthe PBC. Improvements in bankruptcy and foreclosures would also enable banks to recover NPLs.The further development of financial markets apart from imparting market discipline into the system would

have several other advantages.A balanced financial system, where both banks and financial markets play important roles, not only helps inaverting crises, but also creates competitive conditions which would benefit both savers and investors. Thecapital market could help in improving allocative efficiency of resources by putting competitive pressures onthe banking system. The financing needs of the Chinese economy appear to be far more than the lendingcapacity of banks. Those enterprises, which are not able to raise funds from the banking system, couldfinance their requirements from the capital market. The capital market could, thus, help in spurring thegrowth of the private sector.In China, ownership of shares is based on the status of the investor as well as of that of the company. Thereis no transferability between ‗A‘ and ‗B‘ shares, even as they are identical in respect of shareholder rights.  Because of segmentation, the Chinese capital market is also not much integrated with other capital markets.

Further integration with the international capital market could help China in reaping the benefits. Theconvertibility of state and legal person shares into 'A' class shares and making them tradable along with ‗B‘shares could also help in integrating its market further. Reforms of the capital market in China could alsoinclude the development of the private debt market, which could provide the financing choices to theborrowers and the opportunity to diversify risk to the savers.

We draw four main conclusions about China‘s financial system and its future development. First, when

we examine and compare China‘s banking system and financial markets with those of both developed

and emerging countries, we find China‘s financial system is currently dominated by a large banking

system. Even with the entrance and growth of many domestic and foreign banks and financial

institutions in recent years, China‘s banking system is still mainly controlled by the four largest state -

owned banks. All of these ‗Big Four‘ banks have become publicly listed and traded companies in

recent years, with the government being the largest shareholder and retaining control.  

This ownership structure has served these banks well in terms of avoiding major problems encountered bymajor financial institutions in developed countries that are at the centre of the 2007- 2009 global financialcrisis. Moreover, the level of  non-performing loans (NPLs) over GDP has been steadily decreasing afterreaching its peak during 2000- 2001. The continuation of the effort to improve the efficiency of the banking

system, including further development of financial institutions outside the Big Four banks and extendingmore credit to productive firms and projects, is an important task of reforming China‘s financial system inthe short run.

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The Second conclusion concerns China‘s financial markets. Two domestic stock exchanges, the ShanghaiStock Exchange (SHSE hereafter) and Shenzhen Stock Exchange (SZSE) were established in 1990. Theirscale and importance are not comparable to the banking sector; and they have not been effective in allocatingresources in the economy, in that they are highly speculative and driven by insider trading. Going forward,however, financial markets are likely to play an increasingly important role in the economy, and their furtherdevelopment is the most important task for China‘s financial system. We propose several measures that canincrease their size and scope and help to improve the efficiency of the markets.

Third, in an earlier paper, Allen, Qian and Qian (2005, find that the most successful part of the financialsystem, in terms of supporting the growth of the overall economy, is not the banking sector or financialmarkets, but rather a sector of alternative financing channels, such as informal financial intermediaries,internal financing and trade credits, and coalitions of various forms among firms, investors, and localgovernments. Many of these financing channels rely on alternative governance mechanisms, such ascompetition in product and input markets, and trust, reputation and relationships. Together thesemechanisms of financing and governance have supported the growth of a ―Hybrid Sector‖ with various typesof ownership structures.

The definition of the Hybrid Sector includes all non-state, non-listed firms, including privately or

individually owned firms, and firms that are partially owned by local governments (e.g., Township VillageEnterprises or TVEs).1 The growth of the Hybrid Sector has been much higher than that of the State Sector(state-owned enterprises or SOEs, and all firms where the central government has ultimate control) and theListed Sector (publicly listed and traded firms with most of them converted from the State Sector),contributes most of the economic growth, and employs the majority of the labour force.Finally, it was a significant challenge for China‘s financial system is to avoid damaging financial crises thatcan severely disrupt the economy and social stability. China needs to guard against traditional financialcrises, including a banking sector crisis stemming from an accumulation of NPLs and a sudden drop in

 banks‘ profits; China also needs to guard against new types of financial crises, such as a ―twin crisis‖(simultaneous foreign exchange and banking/stock market crises) that struck china‘s economy.

Since its entrance to the World Trade Organization (WTO) in 2001, the integration of China‘s financialsystem and overall economy with the rest of the world has significantly sped up. This process introducescheap foreign capital and technology, but we include firms partially owned by local governments in theHybrid Sector for two reasons. First, despite the ownership stake of local governments and the sometimesambiguous ownership structure and property rights, the operation of these firms resembles more closely thatof a for-profit, privately-owned firm than that of a state-owned firm.

Second, the ownership stake of local governments in many of these firms has been privatized. large scaleand sudden capital flows and foreign speculation increase the likelihood of a twin crisis. At the end of 2007,China‘s foreign currency reserves surpassed US$1.5 trillion, overtaking Japan to become the largest in theworld; it increased to US$2.5 trillion as of June 2010 with a large fraction of the foreign reserve invested inU.S. dollar denominated assets such as T-bills and notes.2 The rapid increase in China‘s foreign exchangereserves suggests that there is a large amount of speculative, ―hot‖ money in China in anticipation of acontinuing (possibly considerable) appreciation of the RMB, China‘s currency, relative to all other major currencies, especially the US dollar. Depending on how the government and the central bank handle theprocess of revaluation, especially when there is a large amount of capital outflow, there could be a classiccurrency crisis as the government and central bank try to defend the partial currency, which in turn maytrigger a banking crisis if there are large withdrawals from banks.

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Challenges Faced by the Financial Sector in India

•  The intermediation cost in India continues to be high in comparison with the international standards.

•  Increased market risk, interest rate risk, liquidity risk, foreign exchange risk and this risk need to bemanaged effectively manner is a serious challenge for bank and the regulatory authority.

•  Emergence of large and complex financial institutions as a result of consolidation could pose a

supervisory challenge.

Financial sector reforms in India have undoubtedly brought about significant improvements in theprofitability of the banking system. However, some issues in the Indian financial system would have to beaddressed in the near future. Furthermore, as a result of deregulation, financial integration and advances ininformation technology,several new challenges have emerged which merit attention in India. Notwithstanding some improvements,the intermediation cost in India continues to be high in comparison with the international standards. In fact,intermediation cost of scheduled commercial banks changed only marginally from 3.0 per cent as at endMarch 2003 to 2.9 per cent by end- March-07. In contrast, intermediation cost in China declinedsignificantly from 2.6 per cent in 2003 to 2.0 per cent in 2007.

The high intermediation cost in India is a cause of concern and it needs to be brought down. Banks are nowexposed to increased market risk. With the increasing financial integration, banks are also exposed to seriousasset and liability mismatch with serious implications for interest rate risk, liquidity risk, foreign exchangerisk. These risks need to be managed in a proactive manner as they pose a serious challenge for the banksand the regulatory authority.

Distinctions among providers of various financial services are getting increasingly blurred which have thepotential to lead regulatory gaps. This, along with the emergence of large and complex financial institutionsas a result of consolidation could pose a supervisory challenge and call for quick and coordinated responseson the part of all the regulatory authorities. Although the capital market in India has become modern, safer

and more transparent, the lack of interest by the retail investor in the market is a cause for concern. The newcapital being raised from the market for the last several years has remained insignificant both in absolute andrelative terms.

As a result, the relative significance of the primary capital market in the financial system has declined In thesecondary market, although there are about 9000 companies listed in the stock exchanges, bulk of the tradingis confined to a few large companies. It is estimated that about 50 stocks make up for as much as 75 per centof the total turnover in the Indian stock exchanges as against 15 each in the case of the US and the UK and25 per cent in the case of Japan. There has also not been any significant progress in the private corporatedebt market. With the major DFIs disappearing from the scene and banks having difficulties to undertakeproject finance in a big way, a gap has emerged in financing the long-term requirements of funds, especiallyfor the infrastructure sector. This could have serious implications for the real sector in the future.

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Conclusion

Financial sector reforms in India and China were introduced more or less at the same time. However, therewere significant differences in the level of development in two systems at the time of introduction of reforms. Whereas, the structure of the financial system in India was already reasonably well developed andmarket-based with private sector and foreign banks operating along with the public sector banks, China, onthe other hand, had to migrate from a totally command economy to a market oriented economy. As a result,the financial system in China continues to face a number of challenges, especially poor asset quality of the

banking system. Future reforms in China need to focus on strengthening the financial system and furtherreforming the capital market. It is significant to note that in terms of size, the Chinese banking system hasemerged significantly larger than that of India. In a globalised world, the size can matter a lot. In order totake advantage of its size, China could focus on quick qualitative improvements, especially in the assetquality of the banking system. The strengthening of the banking system would also enable China to pursuefurther reforms in area of external sector and monetary policy.

Financial sector reforms in India have resulted in significant improvement, especially in the asset quality of the banking system. On the whole, the Indian financial system has emerged much stronger in the post reformperiod. However, the major challenge for the Indian authorities lies in bringing down the intermediation costof the banking system, while at the same time maintaining its profitability.

And It can be finally says that Financial system of India is better than China but China is improving

more and fast on it compared to India.

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References

Global Finance, Archives May 2008

China Banking Regulatory Commission (www.cbrc.gov.cn).

(www.imf.org).

(www.pbc.gov.cn ).