Pro-Bank Tilt of Regulatory Policy

One of the distinctive elements of the financial sector policy is a powerful regulatory
protection extended to the banking system. Faced with a financially weak banking system,
the policy makers have been unwilling to bite the bullet and recapitalise the predominantly
state owned banks to restore their financial health. Instead the policy has been to provide a
cosy regulatory regime in which the dominant oligopolistic banks are insulated from
competition from new entrants as well as competition from non bank sources of capital. The
implicit hope has been that this protected environment will allow them to survive even if they
are financially weak.
• The nature and pace of banking sector reforms has been designed to reduce the ability of
new banks to take market share away from the incumbents by aggressive competition. I
would like to mention in particular the niggardly rate at which new bank licences have
been doled out, a licencing policy that effectively excluded most promoters with deep
pockets, the extreme restrictions on branch expansion and rationalisation, and ill
concealed regulatory hostility to innovation and aggressive marketing. All this meant that
the incumbent big banks faced very little threat from new entrants.
• At the same time, potential competition from outside the banking system was ruthlessly
destro
yed:
The development financial institutions that were financially very sound at the
beginning of the reform process were not allowed to transform themselves into
universal banks until their financial strength had been substantially eroded. This issue
is
described in more detail in 3.4 above
The non bank finance companies (NBFCs) that despite their higher cost of funds
competed intensely with the banks on the basis of speed, flexibility and innovation
were systematically destroyed in the second half of the nineties. In line with
international practices, the NBFCs’ access to retail funds was severely curtailed. At
the same time, the regulatory regime did not allow the NBFCs to fund themselves
eff
ectively in the wholesale markets as they do globally.
The very hesitant moves towards capital account convertibility described in 2.2 above
have meant that the banks have not had to face cross border competition on the scale
that might have been expected in the early 1990s. Moreover restrictions on foreign
banks operating in India have made them less of a competitive threat than they might
ot
herwise have been.
The regulatory regime for money market mutual funds has been designed to prevent
th
em from competing effectively with the banks.
The capital markets have been in a state of decline since the early/mid 1990s for a
variety of reasons as described in 5.9 below. However, one of the contributory factors
has been a regulatory bias towards the banks and against the capital markets. This has
taken several forms including limiting the amount of bank credit to the capital market,
unwillingness to allow exchange clearing houses and depositories direct access to the© Centre for Civil Society, http://www.ccsindia.org. All Rights Reserved.