Bank Financing in India

Abstract

The Indian banking sector has been remarkably successful in some respects. Its immense size and enormous penetration in rural areas are exemplary among developing countries, as is its solid reputation for stability among depositors. The penetration in rural areas has been associated with a reduction of poverty and a diversification out of agriculture.² However, in recent years, it has been widely viewed as being both expensive and inept. In particular, it has been argued that most banks are overstaffed, that a large fraction of their assets are nonperforming, and that they under lend, in the sense of not putting enough effort into their primary task of financing industry.³ A wide range of remedies have been suggested ranging from strengthening the legal system to punish defaulters, to abolishing the targeted lending programs (so-called priority sector rules), to privatization of the entire banking system.

Department of Economics, Massachusetts Institute of Technology (all); Research Associate, National Bureau of Economic Research, and Research Fellow, Center for Economic and Policy Research (Duflo only). This research would not have been possible without generous assistance from several parties. We thank the Reserve Bank of India (RBI), in particular Y.V. Reddy, R.B. Barman, and Abhiman Das, for generous assistance with technical and substantive issues. We also thank Abhiman Das for performing calculations, which involved proprietary RBI data. We are grateful to the staff of the public sector bank we studied for allowing us access to their data. We gratefully acknowledge financial support from the Alfred P. Slone Foundation. Shawn Cole is also grateful for support from a National Science Foundation Fellowship. Finally, we thank Tata Consulting Services, in particular Jayant Pendharkar and M.K. Sen, for their help in understanding the Indian banking industry, and N. Sankaranarayanan for his superb organization of the data collection project.