Impact of banking sector reforms on indian banking system- some developments and challenges ahead

Emerging markets and developing economies face one of the central issues namely strengthening of financial systems. This is due to the reason that sound financial systems serve as an important channel for the achievement of economic growth through the mobilization of financial savings, putting them to productive use and transferring various risks. Many countries adopted a series of financial sector liberalization measures in the late 1980s and early 1990s that included interest rate liberalization, entry deregulations, reduction of reserve requirements and removal of credit allocation. In many cases, the timing of financial sector liberalization coincided with that of capital account liberalization. Domestic banks were given access to cheap loans from abroad and allocated those resources to domestic production sectors. Since the Asian financial crisis of 1997-1999, the importance of balancing financial liberalization with adequate regulation and supervision prior to full capital account liberalization has been increasingly recognized. The crisis was preceded by massive, unhedged short –term capital inflows, which then aggravated double mismatches and undermined the soundness of the domestic financial sector. A maturity mismatch is generally inherent in the banking sector since commercial banks accept short-term deposits and convert them into relatively longer-term, often illiquid, assets. Nevertheless, massive, predominantly short-term capital inflows-largely in the form of inter-bank loans-shortened banks’ liabilities thus expanding the maturity mismatch. This paper focuses on India’s banking sector, which has been attracting increasing attention since 1991 when financial reform programme was launched. This paper throws light on some of the developments that have taken place in the Indian banking sector and challenges ahead for the banking sector as a result of process of banking reforms initiated in 1992.