Comparative study of India and China’s Banking System

KEY STATISTICS US$ in billion Particulars Deposits Savings/ GDP ratio Loans PERFORMANCE INDICATORS All figures in % for the year 2001 Particulars Net interest income (% of total assets) Return on assets Return on stockholders’ equity India 2.33 0.71 13.41 China 2.1 0.4 4.2 India 326 88% 183 China 2,661 57% 2,050

REFORM PROCESS IN THE BANKING SYSTEM India 1. In 1991, the Indian economy went through a process of economic liberalization. 2. Recognizing that the success of economic reforms was contingent on the success of financial sector reform as well, the government initiated a fundamental banking sector reform package in 1992. 3. The banking reform package was based on the recommendations proposed by the Narsimhan Committee Report (1992) that advocated a move to a more market oriented banking system, which would operate in an environment of prudential regulation and transparent accounting. 4. One of the primary motives behind this drive was to introduce an element of market discipline into the regulatory process that would reinforce the supervisory effort of the Reserve Bank of India (RBI). 5. This was particularly critical since market discipline, especially in the financial liberalization phase, reinforces regulatory and supervisory efforts and provides a strong incentive to banks to conduct their business in a prudent and efficient manner and to maintain adequate capital as a cushion against risk exposures. 6. From a central bank’s perspective, such high-quality disclosures help the early detection of problem banks by the market and reduce the severity of market disruptions. Consequently, the RBI as part and parcel of the financial sector deregulation, attempted to enhance the transparency of the annual reports of Indian banks by, among other things, introducing stricter income recognition and asset classification rules, enhancing the capital adequacy norms, and by requiring a number of additional disclosures sought by investors to make better cash flow and risk assessments.

2. and the promotion of debt-equity swaps. 3.China 1. For many years. especially the establishment of a two-tier banking system that comprised primarily a central bank and four specialized banks that are owned fully by the central government. The functioning of the market’s disciplining mechanism and also the effectiveness of the supervisory process is hindered by weak accounting and legal systems. the government launched the second wave of financial reforms. Other reform measures include an attempt to reduce local government intervention. Once the two-tier banking system was formed. 3. the disposal of NPLs held by WSCBs. and the merger and closure of problematic banks. China 1. Perhaps the greatest risk to the Chinese economy is the state of the financial system. banks have yielded to political pressure and extended credit to the least creditworthy in order to keep them in business. Institutional-building focused on the commercialization of specialized banks and a separation between policy and commercial lending activities. Rather than lend on the basis of creditworthiness. the removal of credit allocation. The programs initially focused on institutional reforms to the banking system in the 1980s. Measures to improve management of NPLs include the recapitalization of wholly state-owned commercial banks (WSCBs). 4. 3. The banking sector has remained dominated by the four wholly-owned state commercial banks (WSCB) in the reform period since 1994. Their profitability and cost-efficiency have deteriorated while the level of non-performing loans is still alarmingly high. STATE OF THE BANKING SYSTEM AFTER REFORM India 1. state-owned banks have been lending money to loss-making state-owned companies. Further. attempts are being made with the current budget seeking to make changes to the Securitization Act. and inadequate transparency of accounting disclosures. the impact of the financial reforms has not had a noticeable impact so far on the performance of WSCBs. 2. . 5. especially the State-owned Enterprises (SOE). and a gradual tightening of accounting and prudential regulations. the transformation of urban credit cooperatives into city banks. Competition has emerged. consisting of two major parts: further institutional-building and the management of NPLs. However. but only at the lower end. a narrowing of the scope of business. The law makers are still to provide banks with a powerful law to deal effectively with the problem of willful defaulters. The Chinese government has embarked on a series of financial reform programs since 1979. interest rate and entry deregulation (albeit to a limited extent). 4. 2.

5. especially massive branch expansion and attracting more people to the system. social. and extreme disparities in income. urban. 2. as their Government dominated ownership structure has reduced the conflicts of interest that private banks would face. under the current ownership structure. . 1969. These features are reflected in the structure. it has been relatively easy for the public sector banks to recapitalize. 4. it was subjected to various nationalization schemes in different phases (1955. India has a large population and land size. and the reduction and elimination of private sector monopolies in trade and industry. to attain operational efficiency suitable for modern financial intermediation. banking remained internationally isolated (few Indian banks had presence abroad in international financial centers) because of preoccupations with domestic priorities. For the banking industry to serve as an instrument of state policy. The banking system has had to serve the goals of economic policies enunciated in successive 5-year development plans. the sector has been given the role of providing support to other economic sectors such as agriculture.Peculiarities of Banks in India The banking system in India is significantly different from that of other nations because of the country’s unique geographic. which are marked among its regions. the country has a large reservoir of managerial and technologically advanced talents. with emphasis on self-reliance through import substitution. size. balanced regional economic growth. The country’s economic policy framework combines socialistic and capitalistic features with a heavy bias towards public sector investment. On the other hand. As a result. a diverse culture. 8. particularly concerning equitable income distribution. India has followed the path of growth-led exports rather than the “export led growth” of other Asian economies. given the increases in nonperforming assets (NPAs). and banking activities in metro. & 1980) 3. and economic characteristics. A big challenge facing Indian banks is how. Between about 30 and 35 percent of the population resides in metro and urban cities and the rest is spread in several semi-urban and rural centers. Moreover. & a few semi-urban centers. There are high levels of illiteracy among a large percentage of its population but. 7. and diversity of the country’s banking and financial sector: 1. at the same time. These features have left the Indian banking sector with weaknesses and strengths. The banking system’s international isolation was also due to strict branch licensing controls on foreign banks already operating in the country as well as entry restrictions facing new foreign banks. exports. small-scale industries. 6.

The unorganised sector and microcredit are still preferred over traditional banks in rural and sub-urban areas. they are loosely connected with each other and generally follow separatist tendencies. Diversity of Interest Rates: The Central Banking Enquiry Committee wrote: "The fact that a call rate of 3/4 per cent. a hundi rate of 3 per cent. • Money lenders are great for people who have a bad credit history or have a bad past of bankruptcies because money lenders won’t take these factors into consideration when you apply for your loan where as banks most certainly will." Variations in the interest rate structure are largely due to the credit immobility because of inadequate. • Money lenders are large companies that provide backing in the form of a short term loan. the money lenders are still having an upper hand. In this unorganised sector. 4. 2. coordination and cooperation between the two sectors. costly and time-consuming means of transferring money. Predominance of Unorganised Sector: The indigenous bankers & money lenders occupy a significant position in the moneylending business in the rural areas. no clear-cut distinction is made between short-term and long-term and between the purposes of loans. public and foreign owned commercial banks and cooperative banks) & the unorganised sector (indigenous bankers or money lenders and non-banking financial companies). Because of these reasons commercial banks haven’t weeded out the system of moneylenders in India . a bank rate of 4 per cent. Eg: where a construction building is not yet completed so they need to funds to finish the task. Major defects are discussed below: 1. There is little contact. Due to this hard money lenders charge a much higher interest rate compared to banks to compensate for the risk that they are preparing to take on. They provide most of their short term funding to people who are close to bankruptcy. Most hard money lenders play in a much riskier field compared to banks. but also among the members of the two sectors. The relations between various segments of the money market are not cordial. 3. a bazar rate of small traders of 6.Oraganised and Unorganised sector The Indian money market is classified into: the organised sector (private. Dichotomy between Organised and Unorganised Sectors: The most important defect of the Indian money market is its division into two sectors: (a) the organised sector and (b) the unorganised sector. even after the rise of commercial banks in India. The Indian money market is inadequately developed. • Hence.25 per cent and a Calcutta bazar rate for bills of small trader of 10 per cent can exist simultaneously indicates an extraordinary sluggishness of the movement of credit between various markets. loosely organised and suffers from many weaknesses. Wasteful Competition: Wasteful competition exists not only between the organised and unorganised sectors.

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