Role of Global Financial Crisis on Indian Banking Industry


Mrs. S.Vishnuvarthani
Assistant Professor in Commerce
Vellalar College for Women
Erode, Tamilnadu


Globalization has ensured that the Indian economy and financial markets cannot stay insulated from the present financial crisis in the developed economies. The global financial crisis of 20082009 is an ongoing major financial crisis. It became prominently visible in September 2008 with the failure, merger or conservatorship of several large United States-based financial firms.

The impact on the financial markets will be the following: Equity market will continue to remain in bearish mood with reduced off-shore flows, limited domestic appetite due to liquidity pressure and pressure on corporate earnings; while the inflation would stay under control, increased demand for domestic liquidity will push interest rates higher and we are likely to witness gradual rupee depreciation and depleted currency reserves. Overall, while RBI would inject liquidity through CRR/SLR cuts, maintaining growth beyond 7% will be a struggle. Banks around the world, including those in India, are in the forefront of managing the challenge of crisis resolution.


The global financial crisis, brewing for a while, really started to show its effects in the middle of 2007 and into 2008. Around the world stock markets have fallen, large financial institutions have collapsed or been bought out, and governments in even the wealthiest nations have had to come up with rescue packages to bail out their financial systems.

On the one hand, many people are concerned that those responsible for the financial problems are the ones being bailed out, while on the other hand, a global financial meltdown will affect the livelihoods of almost everyone in an increasingly interconnected world. The problem could have been avoided, if ideologues supporting the current economics models weren't so vocal, influential and inconsiderate of others' viewpoints and concerns.


India too has to withstand the negative impact of the crisis. As the impact on India unfolds, there are two frequently asked questions: First, how is that India is affected when it came out of the Asian crisis relatively unscathed? Second, why is India affected even when its exports account for only 15 per cent of its GDP? The answer to both the questions lies in globalization.

Going by the common measure of globalization, India's two- way trade (merchandise exports plus imports), as a proportion of GDP, grew from 21.2 per cent in 1997-98, the year of the Asian crisis, to 34.7 per cent in 2007-08. The ratio of total external transactions (gross current account flows plus gross capital flows) to GDP,  has increased from 46.8 per cent in 1997-98 to 117.4 per cent in 2007-08. These numbers are clear evidence of India's increasing integration into the world economy over the last 10 years.

There is also another important difference between the crisis in the advanced countries and the developments in India. While in the advanced countries the contagion spread from the financial to the real sector, in India, the slowdown in the real sector is affecting the financial sector, which in turn, has a second-order impact on the real sector.


After the international financial crisis even the most ardent market fundamentalists now recognize that markets often fail, and the governments have to correct the markets equitably and efficiently. During the current financial crisis the government seems to be following a similar conventional approach of market management, without directly addressing the source of the problem. Traditionally during a financial crisis, the Central banks act as lenders of last resort, lending liquidity to the banks. In India, RBI is returning some of the liquidities of the banking system that it held as reserves. As a lender of last resort, RBI would provide such liquidity only to those banks who needed them.

No doubt our banks are suffering from liquidity crunch for sometime, caused by our earlier policy of liquidity withdrawal to manage inflation. The RBI's attempts to contain the fall in the exchange rate of rupee by selling dollar is also withdrawing rupees. Most important however is in falling stock markets, FII investors take away dollars by surrendering rupees. But injection of rupee by the RBI into the system will not necessarily increase bank lending unless borrowers have the confidence in the sustainability of our economy to induce them to increase their investment and the banks have the confidence that these borrowers will be able to pay back.


The Indian banking system is not directly exposed to the sub-prime mortgage assets. It has very limited indirect exposure to the US mortgage market, or to the failed institutions or stressed assets. Indian banks, both in the public sector and in the private sector, are financially sound, well capitalized and well regulated. The average capital to risk-weighted assets ratio (CRAR) for the Indian banking system, as at end-March 2008, was 12.6 per cent, as against the regulatory minimum of nine per cent and the Basel norm of eight per cent. Even so, India is experiencing the knock-on effects of the global crisis, through the monetary, financial and real channels all of which are coming on top of the already expected cyclical moderation in growth.

Our financial markets equity market, money market, forex market and credit market have all come under pressure mainly because of what we have begun to call 'the substitution effect' of: (i) drying up of overseas financing for Indian banks and Indian corporates; (ii) constraints in raising funds in a bearish domestic capital market; and (iii) decline in the internal accruals of the corporates. All these factors added to the pressure on the domestic credit market.


The outlook for India, going forward, is mixed. There is evidence of a slow down in the economic activity. The real GDP growth has moderated in the first half of 2008-09. Industrial activity, particularly in the manufacturing and infrastructure sectors, is decelerating. The services sector too, which has been our prime growth engine for the last five years, is slowing, mainly in the construction, transport and communication, trade, hotels and restaurants sub-sectors. For the first time in seven years, exports have declined in absolute terms in October 2008. Recent data indicate that the demand for bank credit is slackening despite comfortable liquidity in the system. Higher input costs and dampened demand have dented corporate margins while the uncertainty surrounding the crisis has affected business confidence.


The Reserve Bank's monetary policy stance has consistently been to balance growth, inflation and financial stability concerns. When inflation surged earlier this year, the RBI had moved quickly to tighten policy. Then again, reflecting the unfolding global situation and expectation of decline in inflation, RBI has adjusted its monetary stance over the last couple of months. The endeavour of our monetary stance has been to manage liquidity both domestic and forex liquidity and to ensure that credit continues to flow for productive activities.


The RBI has taken several measures aimed at infusing rupee as well as foreign exchange liquidity and to maintain credit flow to productive sectors of the economy. Measures aimed at expanding the rupee liquidity included significant reduction in the cash reserve ratio (CRR), reduction of the statutory liquidity ratio (SLR), opening a special repo window under the liquidity adjustment facility (LAF) for banks for on-lending to the non-banking financial companies (NBFCs), housing finance companies (HFCs) and mutual funds (MFs), and extending a special refinance facility, which banks can access without any collateral. The Reserve Bank is also unwinding the Market Stabilization Scheme (MSS) securities, roughly synchronized with the government borrowing programme, in order to manage liquidity.

The Reserve Bank has also instituted a rupee-dollar swap facility for banks with overseas branches to give them comfort in managing their short-term funding requirements. Measures to encourage flow of credit to sectors which are coming under pressure include extending the period of pre-shipment and post-shipment credit for exports, expanding the refinance facility for exports, counter-cyclical adjustment of provisioning norms for all types of standard assets (except in case of direct advances to agriculture and small and medium enterprises which continue to be at 0.25 per cent) and risk weights on banks' exposure to certain sectors which had been increased earlier counter-cyclically, and expanding the lendable resources available to the Small Industries Development Bank of India (SIDBI), the National Housing Bank (NHB) and the Export-Import Bank of India (EXIM Bank).


The following are the major challenges facing the banking system in the country, particularly in the wake of the global financial crisis:

The First Challenge: Maintaining the Credit Flow

The outlook, both for the world and for India, continues to remain uncertain. The future trajectory of the global crisis is not yet clear. The year 2009-10 remained more challenging one. There was a noticeable decline in the credit demand in the month of November 2008 but it is not yet clear if it was a one off episode or it reflects a trend. If it is indicative of slowing economic activity, it would be a major challenge for the banks to ensure healthy flow of credit to the productive sectors of the economy. The economic growth, even in normal times, requires efficient financial intermediation. An economic downturn, therefore, requires even more efficient financial intermediation and this is a major challenge that the banking community has to address. There is a need to ensure a steady credit flow to the real sector of the economy in order to sustain demand even while maintaining credit quality.

The Second Challenge: How Do We Reform Financial Sector Regulation?

By far, the most contentious and most voluble debate triggered by the crisis has been about the flaws in the regulatory architecture of the financial sector. Several issues have come to the fore which includes: How can complex derivative products, which transmitted risks across the system, be made more transparent? What are the financial stability implications of structured products like credit derivatives? Are exchange traded derivatives better than over-the-counter (OTC) derivatives? How do we eliminate the drawbacks of the 'originate-to- distribute' model?  Is universal banking, the model that the United States has now turned to, appropriate? Can the same regulatory regime can be applied for both wholesale and retail banks?

The burden of all the above questions is to identify the drawbacks in the present regulatory regimes and indicate possible solutions. The first thing to remember is that no one size fits all curve. There is no denying that regulations have to keep pace with innovations in the financial markets but in doing so, we must be mindful of the risks of over-tightening the regulations lest they stifle innovation.

The Third Challenge: Regulatory Forbearance and Relaxing Regulatory Norms

There has been a sustained demand from various quarters for exercising regulatory forbearance in regard to extant prudential regulations applicable to the banking sector. As a part of counter-cyclical package, several changes have already made to the current prudential norms. These include: (a) reduction in the risk weights for claims on unrated corporate and commercial real estate to 100 per cent; (b) reduction in the provisioning requirement for all standard assets to 0.40 per cent; (c) permitting housing loans to be restructured even if the revised payment period exceeds ten years; (d) making the restructured commercial real estate exposures eligible for special treatment if restructured before June 30, 2009.

The Fourth Challenge: Effective Implementation of Basel II Framework

A part of the Indian banking system has already migrated to the Basel II Framework effective March 31, 2008 and the remaining commercial banks are slated to do so by March 31, 2009. However, having regard to the state of preparedness of the system, for the present, only the simpler approaches available under the Framework has been adopted. The RBI is yet to announce the timeframe for adoption of the Advanced Approaches in the Indian banking system but the migration to these Approaches is the eventual goal for which the banking system will need to start its preparations in all earnestness.

The Fifth Challenge: The Challenge of Banking Development and Financial
Inclusion in Eastern India

Banking development in the eastern region of the country, as measured by several parameters, is lagging behind the national average. In terms of infrastructure coverage and other development indicators, the eastern region is not as developed as other regions of the country. Admittedly, this affects the credit absorption capacity and may also explain some of the lagging parameters mentioned above. However, this can not be an excuse for inaction. It should be impetus for vigorous action.


Going forward, developments in the real economy, financial markets and global commodity prices point to a period of moderation in growth with declining inflation. What is heartening though is that the fundamentals of our economy continue to be strong. Once calm and confidence are restored in the global markets, economic activity in India will recover sharply. But a period of painful adjustment is inevitable. It is the collective challenge for the bankers, and the RBI to respond to this extraordinary situation effectively and return India to its path of growth and poverty reduction.


2. Global Financial Crisis, US Recession, Its impact on the world economy and Indian response, Organisational Management, Vol.XXIV, No.3, Oct-Dec 2008, pp-53-56.
3. Global Integration of the Indian Economy, Dr.K.A.Rasure, Facts for you, January 2009, pp- 32 -34

Mrs. S.Vishnuvarthani
Assistant Professor in Commerce
Vellalar College for Women
Erode, Tamilnadu

Source: E-mail July 7, 2012


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