Comparative study of India and Chinas 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 banks 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.

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

Peculiarities of Banks in India

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

Oraganised and Unorganised sector

The Indian money market is classified into: the organised sector (private, public and foreign owned commercial banks and cooperative banks) & the unorganised sector (indigenous bankers or money lenders and non-banking financial companies). The unorganised sector and microcredit are still preferred over traditional banks in rural and sub-urban areas. Money lenders are large companies that provide backing in the form of a short term loan. They provide most of their short term funding to people who are close to bankruptcy. Eg: where a construction building is not yet completed so they need to funds to finish the task. Most hard money lenders play in a much riskier field compared to banks. 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. Money lenders are great for people who have a bad credit history or have a bad past of bankruptcies because money lenders wont take these factors into consideration when you apply for your loan where as banks most certainly will. Hence, even after the rise of commercial banks in India, the money lenders are still having an upper hand. The Indian money market is inadequately developed, loosely organised and suffers from many weaknesses. Major defects are discussed below: 1. 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. There is little contact, coordination and cooperation between the two sectors. 2. Predominance of Unorganised Sector: The indigenous bankers & money lenders occupy a significant position in the moneylending business in the rural areas. In this unorganised sector, no clear-cut distinction is made between short-term and long-term and between the purposes of loans. 3. Wasteful Competition: Wasteful competition exists not only between the organised and unorganised sectors, but also among the members of the two sectors. The relations between various segments of the money market are not cordial; they are loosely connected with each other and generally follow separatist tendencies. 4. 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, a bank rate of 4 per cent, a bazar rate of small traders of 6.25 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." Variations in the interest rate structure are largely due to the credit immobility because of inadequate, costly and time-consuming means of transferring money.
Because of these reasons commercial banks havent weeded out the system of

moneylenders in India