10.1 Introduction

In Chapter 9, we discussed management of banking assets such as bank loans and investments. Broad considerations on profitability, solvency and liquidity guide overall strategic decisions on the volume and type of bank lending and pricing of loans. Operational decisions related to items on the liabilities side of a bank's balance sheet are equally important and are covered in this chapter.

During the post-reform period, banks assumed adequate operational autonomy as regards deposit mobilisation and fixing of interest rates on deposits as well as exploration of several sources of borrowings. This has created a highly competitive environment for mobilising deposits by attracting customers through aggressive marketing and pricing strategies. Banks are heavily reliant on borrowings not only for day-to-day liquidity management but also to raise capital from the market for meeting tier-2 capital requirements under the Basel norms.

OBS items such as bank guarantees, LCs, acceptances and endorsements have been offered by banks in India to facilitate trade and business. Contingent upon failure of the counterparty to honour the underlying transaction, any OBS item can become an effective liability. Hence, such items are popularly referred to as contingent liabilities. These items are not real bank liabilities as long as they are not crystalised. During the post-reform period, not only has the volume of transactions in traditional OBS items like bank guarantees and LCs significantly multiplied, new financial derivatives mainly pertaining to foreign exchange (forex) contracts have also become very popular. Given the importance of OBS items in the banking business in recent times, this chapter also briefly discusses management of these items.

There have been competing and conflicting ideas about diseases in different phases of human civilization, and none of them is said to be exclusively deterministic and universally acceptable. Disease has been defined in a way society wanted it to be defined, and consequently, the concept and ideas of illness are found to be changing with the changes of time and culture. More importantly, an interpretative rather than positivist approach to determining the definition of disease or illness has also been given by historians, sociologists, and anthropologists. This book is not intended to revisit this area and re-examine it. Broadly speaking, disease may be, in the light of modern medical research, due to several groups of causes, and specific aetiology for a specific disease has been established after the discovery of germ theory. It may be due to congenital defects or faulty working of the organs or may be the result of improper nutrition. There are certain diseases caused by some microbes (viruses, bacteria, or parasites), which are communicable from one person to another. This is the most important category of diseases from the point of view of public health services because these diseases can be prevented, and many can be successfully treated. Many such diseases, which caused havoc in colonial India, still pose a serious threat to the state and the people.

The most panic-inducing disease in British India was fever, which, in one form or another, had taken millions of lives. Besides mortality, fever also caused thousands of cases of illness, leaving the affected people weak, listless, and wrecked. British India experienced various types of fever, such as Burdwan fever, Dumdum fever, malarial fever, and so on—black fever, known as kala-azar (visceral leishmaniasis), being one of the most dangerous among them. Kala-azar was widely prevalent in colonial eastern India but was not only an Indian disease. It was rather a widespread disease and occurred in many parts of the world during the period under study, exhibiting its presence in China, Arabia, Sudan, Central Africa, Tunis, Sicily, Italy, Algeria, Crete, Spain, Portugal, Greece, Malta, Turkestan, Central and South America, South Africa, and so on.

2.1 Introduction

The Indian financial system has evolved over time, keeping pace with the country's economic development and changing policy paradigms. Since independence, the overall policy paradigm assigned a critical role to the banking sector in financing the Indian development process. Initially, efforts involved bringing large commercial banks under government control, facilitating a massive expansion in banking since 1969. To supplement commercial banks, cooperative banks were activated and regional rural banks (RRBs) were established with the specific objective of promoting the financing of agriculture and rural economic activities. The post-reform period witnessed the emergence of a broad-based financial sector in India with the development of different segments of the financial markets and other financial institutions.

It is important to note that notwithstanding the development of other constituents of the Indian financial system during the post-reform period, commercial banks continued to be the dominant segment. Chapter 1 provided an introduction to banking in general. In this chapter, we will discuss in some detail the banking system in India.

Section 2.2 provides an overview of the Indian financial system, particularly with the objective of gaining a comparative perspective on commercial banks. This section introduces the key constituents of the Indian financial market such as the equity market, government securities market, corporate bond market, money market and forex market. Information about different financial institutions in India such as cooperative banks, RRBs, non-banking financial companies (NBFCs) and development finance institutions (DFIs) is also provided. Next, section 2.3 traces the evolution of commercial banking from a historical perspective.

3.1 Introduction

The state of the economy of a country is characterised by several indicators such as GDP, consumer price index (CPI), balance of payments (BOP), money stock, government expenditure, savings and investment, interest rate, and so on. Such indicators represent different aspects of an economy. For example, BOP captures international transaction of goods and services as also cross-border capital flows. CPI is a proxy for general prices. Amongst all these, GDP is the most important indicator and popularly used as a barometer to measure the size of economic activity in a country. It captures the sum of market values of all final goods and services produced in a country during a particular period such as a year or a quarter. Standard macroeconomics textbooks provide details about the concept and measurement of such indicators.

GDP is treated as a proxy for the total amount of income generated in an economy. Owners of capital and land, suppliers of raw materials and other factors of production such as workers, entrepreneurs, and so on, earn their income by participating in the production of goods and services. The total revenue earned from the sale of goods and services produced is distributed amongst these stakeholders. For producing more output, higher number of workers, larger amount of capital and raw material, and so on, are required. Accordingly, more output entails generation of more aggregate income for all the stakeholders who participated in the production process.

An economy is characterised by a variety of macroeconomic indicators such as gross domestic product (GDP), employment, savings and investment, general prices, interest rates, taxes and government borrowing/debt, banking and finance, exports, imports, and so on. Amongst all, GDP, which captures aggregate production or output of a country, stands out as the most important barometer to measure overall economic activity. Production of goods and services in a country generates commensurate income for various stakeholders engaged in the production process and enables them to buy and consume various goods and services. Economic welfare in a country is assessed by the amount of goods and services produced and consumed by its citizens. In a rich country like the United States or Japan, with higher level of production and income generation, the citizens can afford a high level of standard of living. They enjoy access to nutritious food, quality health care, better air conditioning, automobiles and vacation, and so on. On the contrary, a sizeable number of citizens in poor or low- and middle-income countries lack access to even basic needs like food and safe drinking water, reflecting low standard of living.

The growth theories explain, inter alia, how the rich countries in the world could achieve and sustain their economic progress over a long period of time stretching more than a century, and also why many countries in Africa and Asia have not been able to do so. Particularly, proximate causes are identified in terms of accumulation of capital through mobilisation of savings, population growth supplying labour or workers, and improvement of labour productivity through innovations and technological changes. A more fundamental role is assigned to economic and political institutions.

In the aforementioned process of attaining and sustaining economic prosperity in an economy, banks play a special role. In fact, the very functioning and progress of any modern economy is inconceivable without banks and other entities of the financial system. First, banks are financial intermediaries which generate deposits from the public and utilise the mobilised deposits to provide loans and undertake investments. In this process, banks play a crucial role towards augmentation of savings and efficient allocation of resources for productive investments. Consequently, banks assume a vital role towards achieving and sustaining economic growth in a longer-term perspective.

6.1 Introduction

The facilitating role of banks towards promoting and sustaining prosperity in an economy has already been discussed in the preceding chapters. An analogy can be drawn between the banking sector and nuclear plants. Nuclear power has emerged as a formidable alternative to fossil fuels for meeting energy requirements. It has many advantages in terms of proficiency, reliability, ecofriendly aspects and low cost. However, any accident or mishandling in a nuclear plant can potentially cause severe devastation and loss of life. Similarly, the banking sector promotes economic growth in several ways and acts as a critical channel of the MTM to control inflation and mitigate economic fluctuations. At the same time, the banking business entails inherent risks. If the risks embodied in banking are not contained within reasonable prudential limits, they can severely harm the economy.

Any ordinary business involves risks due to fluctuations in sales, production costs, shortage in availability of raw materials, disruptions in the supply chain, employee unrest, deteriorating physical infrastructure, and so on. But the dimensions, configurations and magnitude of risks in the banking business are much wider than those in any non-financial business. Higher risk in banking is mainly explained using underlying bank-specific features such as information asymmetry in and excessive procyclicality of bank lending, scope for bank runs and contagion, and so on. Details of these aspects are discussed in section 6.2.

Ben S. Bernanke, Nobel laureate for economics in 2022, has highlighted how failure of banks can aggravate a conventional economic crisis (Bernanke, 1981, 1983).

4.1 Introduction

In Chapter 3, we discussed the role of banks in augmenting savings and supporting economic growth in the long-term perspective. In macroeconomics, ‘long-run’ refers to the period in which all prices are flexible. In practice, long-run economic growth and developmental discussion for a country generally cover several decades.

There is another important dimension of economic growth often observed. This is in the form of short-term economic fluctuations. Short run refers to a time period in which the prices of some goods are assumed to be rigid or inflexible. The evolution of Keynesian macroeconomics in the aftermath of the Great Depression of the 1930s highlighted the occurrence of such regular short-term economic fluctuations. It was suggested that there are certain phases in which the economy witnesses rapid growth (boom) followed by periods of economic slowdown (recession). The periodic recurrence of such economic booms and recessions is popularly referred to as the business cycle phenomenon.

The question is why we need to be concerned with short-run economic fluctuations.

Our concerns arise as excessive economic fluctuations can have serious adverse effects on society. During economic downswings, sales, production and employment levels plummet. Most households earn their livelihood by participating in the production process in one form or the other. Fall in production and sales adversely affects the profits of industry and unemployment causes loss of income for households. Consequently, the livelihood and standard of living of people at large suffer. Any social-welfare-maximising government cannot afford serious risks to the livelihood and standard of living of its citizens.

Similarly, periods of economic boom, particularly if driven by rising aggregate spending in the economy as compared to the production capacity, cause high inflation. Inflation is nothing but a tendency of continuous surge in the general prices. With rising prices, people can afford to buy fewer goods and services for a given income.