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FINANCIAL MARKETS
Indian Financial Sector
Need for integration
With globalization of the financial sector; it's time to recast the
architecture of the Indian financial system.
he growth in the service sectors
T in the last decade has been much
higher than that of manufacturing
and agriculture.
The share of service sector is nearly
Credit delivery mechanism
The credit availed by these sectors
comes from sellers (in the form of
payables/receivables) or from 'open
50% of the economy during 2000-01 market' (non-bank) sources and from
and it is the fastest growing sector of the bank sources.
economy clocking more than 8% during
the period. The financing of the activities
undertaken by the non-corporate
Four sectors namely trade, transport sectors particularly in areas like trade
(other than railways), construction and (wholesale and retail), hotels and R Vaidyanathan
hotels and restaurants constitute Professor of Finance
restaurants is mainly from the private
dominant portions of the service sector 11M - Bangalore
money markets where the rates of
other than business and professional interest are much higher, at least twice
services. Actually, trade constitutes that of the government banks. These
third largest chunk of the economy are on cash flow-based lending rather
(share of 13% (in the GDP in 2000- In the recent past, interest rates have
than on asset-based and are undertaken been moving south and many a large
2001) after agriculture (26%) and more by the unincorporated type of
manufacturing (16%). corporates are in a position to access
financing agencies. funds from banks at less than 10%. But
The organized non-banking sector my flower girl and my vegetable vendor
Non-corporate organizations is more in asset-based lending for items get it at half percent per day. (Returning
like equipments, trucks etc. This is one half rupee for hundred rupee borrowed
These activities are conducted by in the morning.) This will work out to be
partnership/proprietorship type of of the major reasons for the large
more than 180% per annum. My r etail
organizations (non-corporate) with active margins seen in trade, both wholesale
provision stores man gets it in an
involvement 'from members of family and retail. For many of the Fast Moving interesting way. He gets Rs. 45,000 (for
and community. We find that in trade the Consumer Goods (FMCG) we find the a loan amount of Rs. 50,000) up front
share of non-corporate sector is more gap between the company balance and pays Rs. 500 per day for 100 days to
than 80% and in non-railway transport it sheet figure and the street price figures repay Rs. 50,000. It turns out to be more
is above 75% and so is the case in hotels to be more than 35% and one factor in than 10% for three months. My barber
and restaurants. It is important to this is the 'open market' interest paid by gets it through a local chit process at
understand that corresponding the trade channels. . around 4% per month. The fast food
proportions in developed market restaurant (Idli joint) at the corner of the
In the case of cash crops and
economies are less than 10%. road gets funds at 3% per month from a
vegetables, the gap between producer
non-bank agency. The private bus
prices and consumer prices can be as
In other words, developed markets, high as 70 to 80%. Here again the operator in the suburbs gets it at 2.5%
are significantly corporatized in the financing cost both for holding and and the construction contractor near
activities like trade, construction, hotels transport plays a major role. home gets it at 3% per month. The
and restaurants, transport etc. plumber, carpenter, fitter, painter etc.-,
gets funds at 3 to 4% per month.
CHARTERED FINANCIAL ANALYST. December 2003
INDIAN FINANCIAL SECTOR
The segmented financial markets There is a need to understand the return- company utilizing the resources and
present an ironical (if not tragic) picture risk paradigm of any financial operation contacts of local merchants to act as their
of huge funds available with bankers on and these entities are into cash flow- stockists and distributors' to retail their
the one hand and prohibitive interest based lending as in activities like trade, products in the market. -Already, we
rates at which funds are accessed by hotels, construction etc. They do not find that in truck financing the MNC
trade and commerce particularly the have the benefit of the sovereign banks are utilizing the NBFCs as
non-corporate sector on the other. As guarantee provided to public sector channel partners.
already seen, the non-corporate sector banks nor have they any insurance Hence, the public sector banks
has dominant role in activities like trade facility as given to bank deposits. They could finance the non-bank financial
(wholesale and retail) construction, also do not have the ‘comfort letters’ institution on a wholesale basis and they
hotels and restaurants, private transport provided to the MNC bankers in India in turn could fund the requirements of
and other services. Hence, we are not by their parent’s abroad. the non-corporate
talking here of some "residual' segments. The segmented sectors in a chain of
In such situation, retailing credit and
These sectors constitute nearly 30% of
our economy and they are the fastest some failures are to be financial markets recovery functions. If
growing 'service sector' in the last expected when we are present an ironical the banks finance the
dealing with lakhs of
decade, mostly above 8% per annum. picture of huge funds NBFCs after rating
institutions. In the case them even at 4-5%
of failure of commercial available with bankers above Prime Lending
Concentric circle of banking banks particularly on the one hand and Rate (PLR), then these
institutions public sector banks, it prohibitive interest institutions could fund
There is a need to integrate' domestic is explained as ‘systemic‘ the non-corporate
rates on the other. sector at perhaps 8-
financial markets through a system of failure and government
pumps substantially more funds in for 10% over and above PLR. This would
making UIBs in the credit market as
recaptalizing these institutions. still be lower than the open market rates
channel partners to large banks, The
of two and half to three times the PLR at
reforms have focused only on the liability The chances failure of completely which this sector, in many of these
side of NBFS and failures therein, but the private institutions with significant risk activities.
assets side is equally important in terms of
taking activities are expected to be The financing to non-bank
credit delivery to large segments of our larger compared to government-owned, organizations (both corporate and
economy. controlled and monitored institutions. unincorporated) by the commercial
Protecting the depositor interest should banks should be treated on par with
The significant role played by the go hand in hand with enhancing the priority sector lending as long as the
non-bank institutions in the credit credit delivery mechanism to the largest end use is to these sectors. This
delivery mechanism has not been
appreciated nor fully understood by the sections of our economy, which are not implies that the commercial banks
banks-dependent for their activities. gear themselves, in rating the non-
policy planners. The focus is more on banking organizations rather than
failure of some institutions. There have
In a sense, the non-banking finance thousands of unincorporated entities in
been failures in the non-bank sector in
companies, both corporate as well as trade, transport, construction, and
terms of institutions in both corporate
and other forms of business. . non-corporate, are the best route to hotels and restaurants. We elaborate
finance these activities of the non- on this later.
.
There are two types of failures. One corporate sector particularly for future In the case of non-corpo'1'ate entities
belongs to the, class of malfeasance on 'income-based' lending. This is due to in the market, the commercial banker
the part of promoters in terms of running the fact that in their area they are can be given the powers to license
these institutions, which has resulted in market-savvy and, have the ability to them and provide credit to them to
loss to the depositors. This is related' rate the partnership/proprietorship reach the larger market. It can also be
to the operational and supervisory groups and monitor them and recover specified that only licensed non-
mechanism. The other type of failure is the money lent to them. corporate bodies will be permitted to
related to riskiness of the underlying operate in the credit market in terms
assets invested in, by these entities and. It would, seem appropriate to cite here of collecting deposits and also
that is part of business risk phenomena the analogy of a. large manufacturing availing of loans from the banking
institutions.
''
CHARTERED FINANCIAL ANALYST. December 2003 INDIAN FINANCIAL SECTOR
This would provide opportunities to Recognizing the important role, of
banks to enlarge their scope of NBFS (both corporate and
operations and also provide the UIBs to unincorporated), the credit
carry on their business with loans from markets of our economy collect data to
the banking system. It will also introduce estimate their share to enhance the credit
orderliness in terms of banks rating these delivery to millions of service entities.
entities for licensing them and reviewing Commercial banks can lend to these non-
annually. The depositors are also banking institutions that in turn can
protected to some extent in the context of provide it to the business entities.
assessment by the commercial banks for
licensing them. Globalizing our financial sector
This concentric circle without domestic'integration of the
of banking will bring to Financial markets may
an end the current lead to a situation of
inverse relationship It is required for us to cherry picking by the
between size of recast the global players and or
borrowings and the cost architecture of the linkages created only at
of borrowings without the 'creamy layer' level
Indian financial
much application of without adequate
credit rating of the system if it has to strengthening of the
borrower. It would also ensure growth of the base of the system.
facilitate creation of economy along with
proper database in these The paradigm of
activities for credit rating
adequate availability taking the UIBs as
of these entities. of credit channel partners by the
commercial banks
in a large scale would facilitate the
Need for integration players in these fastest growing
There are efforts by government both at activities to compete effectively with
Central and State level to allow global global players in the emerging scenario.
companies into activities like retail trade,
transportations and construction and
restaurants. If the competition from the It is required for us to recast the
international giants have to be architecture of the Indian financial
effectively. met by our local institutions, system if it has to ensure growth of the
then cost-effective and efficient credit economy along with adequate
delivery mechanism is important for the
availability of credit to the fastest
current players.
growing sectors of the economy.
The trend in commercial banks today
is to merge existing branches rather than. The aggregate monetary policy of
create new ones, particularly in the the Central Banker can be achieved if
context of the voluntary retirement and only if the role of non-banking
schemes introduced. In such a situation, financial institutions including the UIBs
it may not be possible for commercial are recognized 'and encouraged in our
banks to enlarge the network necessary financial system.
to cover a larger portion of the" non-
corporate sector in future. That would leave
an. unserviced gap.
Reference # 1 -2003-12-05
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