Essay on the Role of Banking in the Indian Economy

Banking as an industry processes cash, credit, and other financial transactions. Banks provide a safe place to store extra cash and loans. They offer savings accounts, certificates of deposit, and checking accounts. Bank loans and credit mean that families don't have to save before going to college or buying a house. Banking plays a significant role in the economy of any nation. In this essay, I am going to take a closer look at its conception in the context of the Indian economy.

Talking about the role of banking in the economy of India, it should be noted that it plays a crucial role in capital formation. The significance of DFIs - development finance institutions - lies in their making available the means to utilize savings generated in the economy, thus helping in capital formation. Capital formation implies the diversion of the productive capacity of the economy to the making of capital goods, which is a rise in the size of future productive capacity. The process of capital formation involves three distinct but interdependent activities: savings, financial intermediation, and investment. However, poor country/economy may be, there will be a need for institutions that allow such savings, as are currently forthcoming, to be invested conveniently and safely and which ensure that they are channeled into the most useful purposes. A well-developed financial structure will therefore aid in the collection and disbursement of investible funds and thereby contribute to the capital formation of the economy. Indian capital market although still considered to be underdeveloped, it has been recording impressive progress during the post-interdependence period.

In addition, banking in India supports the capital market. The basic purpose of DFIs, particularly in the context of a developing economy, is to accelerate the pace of economic development by increasing capital formation, inducing investors and entrepreneurs, sealing the leakages of material and human resources by careful allocation thereof, undertaking development activities, including promotion of industrial units to fill the gaps in the industrial structure and by ensuring that no healthy projects suffer for want of finance and/or technical services. Hence, the DFIs have to perform financial and development functions on finance functions, there is a provision of adequate term finance and development functions there including providing of foreign currency loans, underwriting of shares and debentures of industrial concerns, direct subscription to equity and preference share capital, guaranteeing of deferred payments, conducting techno-economic surveys, market and investment research and rendering of technical and administrative guidance to the entrepreneurs.

Rupee loans constitute more than 90 percent of the total assistance sanctioned and disbursed. This speaks eloquently on banks' obsession with term loans to the neglect of other forms of assistance which are equally important. Term loans unsupplemented by other forms of assistance had naturally put the borrowers, most of whom are small entrepreneurs, on to a heavy burden of debt-servicing. Since term finance is just one of the inputs but not everything for the entrepreneurs, they had to search for other sources, and their abortive efforts to secure other forms of assistance led to sickness in industrial units in many cases.

Foreign currency loans are meant for setting up new industrial projects, as well as for expansion, diversification, modernization, or renovation of existing units in cases where a portion of the loan was for financing the import of equipment from abroad and/or technical know-how in special cases.

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Regarding guarantees, it is well-known that when an entrepreneur purchases some machinery or fixed assets or capital goods on credit, the supplier usually asks him to furnish some guarantee to ensure payment of installments by the purchaser at regular intervals. In such a case, banks can act as guarantors for prompt installments to the supplier of such machinery or capital under a scheme called ‘Deferred Payments Guarantee’.

It should also be noted that banking in India plays an important role in assisting backward areas. Operations of DFIs in India have been primarily guided by priorities as spelled out in the Five-Year Plans. This is reflected in the lending portfolio and pattern of financial assistance of development financial institutions under different schemes of financing. Institutional finance to projects in backward areas is extended on concessional terms, such as lower interest rates, longer moratorium periods, extended repayment schedules, and relaxed norms concerning promoters’ contribution and debt-equity ratio. Such concessions are extended on a graded scale to units in industrially backward districts, classified into the three categories of A, B, and C depending upon the degree of their backwardness. Besides, institutions have introduced schemes for extending term loans for project/area-specific infrastructure development. Moreover, in recent years, development banks in India have launched special programs for intensive development of industrially least developed areas, commonly referred to as the no-industry districts (NIDs), which do not have any large-scale or medium-scale industrial projects. Institutions have initiated industrial potential surveys in these areas.

Banking in India also plays an important role in the promotion of new entrepreneurs. Development banks in India have also achieved remarkable success in creating a new class of entrepreneurs and spreading the industrial culture to newer areas and weaker sections of society. Special capital and seed capital schemes have been introduced to provide equity type of assistance to new and technically skilled entrepreneurs who lack financial resources of their own even to provide promoter’s contribution given long-term benefits to the society from the emergence of a new class of entrepreneurs. Development banks have been actively involved in entrepreneurship development programs and in establishing a set of institutions that identify and train potential entrepreneurs. Again, to make available a package of services encompassing preparation of feasibility of reports, project reports, technical and management consultancy, etc. at a reasonable cost, institutions have sponsored a chain of 16 technical consultancy organizations covering practically the entire country. Promotional and development functions are as important to institutions as the financing role. Promotional activities like carrying out industrial potential surveys, identification of potential entrepreneurs, conducting entrepreneurship development programs, and providing technical consultancy services have contributed in a significant manner to the process of industrialization and the effective utilization of industrial finance by industry. IDBI has created a special technical assistance fund to support its various promotional activities. Over the years, the scope of promotional activities has expanded to include programs for up gradation of skills of state-level development banks and other industrial promotion agencies, conducting special studies on important issues concerning industrial development, encouraging voluntary agencies in implementing their programmers for the uplift of rural areas, villages and cottage industries, artisans and other weaker sections of the society.

A final point to discuss in the context of the role of banking in the Indian economy is its impact on corporate culture. The project appraisal and follow-up of assisted projects by institutions through various instruments, such as project monitoring and report of nominee directors on the boards of directors of assisted units, have been mutually rewarding. Through monitoring of assisted projects, the institutions have been able to better appreciate the problems faced by industrial units. It also has been possible for the corporate management to recognize the fact that the interests of the assisted units and those of institutions do not conflict but coincide. Over the years, institutions have succeeded in infusing a sense of constructive partnership with the corporate sector. Institutions have been going through a continuous process of learning by doing and are effecting improvements in their systems and procedures based on their cumulative experience. The promoters of industrial projects now develop ideas into specific projects more carefully and prepare project reports more systematically. Institutions insist on a more critical evaluation of technical feasibility demand factors, marketing strategies, and project location and on the application of modern techniques of discounted cash flow, internal rate of return, economic rate of return, etc. in assessing the prospects of a project. This has produced a favorable impact on the process of decision-making in the corporate seeking financial assistance from institutions. In fact, such impact is not continued to projects assisted by them but also spreads over to projects financed by the corporate sector on its own. The association of institutions in the management of corporate bodies has considerably facilitated the process of progressive professionalism of corporate management. Institutions have been able to convince corporate management to appropriately re-orient their organizational structure, personal policies, and planning and control systems. In many cases, institutions have successfully inducted experts on the boards of assisted companies. As part of their project follow-up work and through their nominee directors, institutions have also been able to bring about progressive adoption of modern management techniques such as corporate planning and performance budgeting in the assisted units. The progressive professionalism of industrial management in India reflects one of the major qualitative changes brought about by the institution.

The banking sector is an important component of the financial sector of any country, it is the backbone of the nation's economic system. India is no exception. As this essay has confirmed, the role of banking in the Indian economy is significant.