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India’s Need for Bank-Based Finance

The document discusses the pros and cons of bank-based versus market-based financial systems, and argues that a bank-based system is currently better for India. It notes that both systems can work well for different countries. While market-based systems may be superior for developed nations like the U.S. and U.K., India's stock market and legal framework are still developing. Additionally, India faces greater macroeconomic challenges and vulnerabilities than other nations due to its unique history and geopolitical situation. For these reasons, the document concludes that India should maintain its current pseudo bank-based system until it makes further progress on equity market penetration, legal protections, and macroeconomic stability.

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67 views2 pages

India’s Need for Bank-Based Finance

The document discusses the pros and cons of bank-based versus market-based financial systems, and argues that a bank-based system is currently better for India. It notes that both systems can work well for different countries. While market-based systems may be superior for developed nations like the U.S. and U.K., India's stock market and legal framework are still developing. Additionally, India faces greater macroeconomic challenges and vulnerabilities than other nations due to its unique history and geopolitical situation. For these reasons, the document concludes that India should maintain its current pseudo bank-based system until it makes further progress on equity market penetration, legal protections, and macroeconomic stability.

Uploaded by

PremChandar
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
Available Formats
Download as DOCX, PDF, TXT or read online on Scribd

Prem Chandar S - PGP/23/408

U Aakash - PGP/23/062

Which is better for India - Bank based or Market based Financial systems?

According to Neo Classical Economics, the financial sector acts mainly as an


intermediary place between the firms and the households. It signifies that the maximum
efficiency is achieved only if the State interferes/regulates when necessary and that too
marginally. The major short coming of this theory is that how complex the financial system is
in real life. There comes the problem between the Market based vs Bank based Financial
systems.

In bank-based financial systems, banks play a vital role in capital allocation, over
heading the investment decisions, and offering risk management tools. In market-based
financial systems, securities markets hold the maximum say in how things pan out. Equity
penetration shares equal power with the banks with the State maintaining a mediator or
regulator role. And many researchers and economic scholars argue that the market based
financial system is the superior one as it works in U.S and U.K. But is it so?

All know about the Great Depression 1929, the Germany banking crisis 1931, and the
1927 crisis in Japan. All these nations wanted to redefine the financial sector, Germany and
Japan went for Bank Based and U.S went for market based. But all these economies are
successful right? So, no system is better than the other one. To choose a financial system for
the country it relies on many factors including, Equity market penetration, can the banks hold
during a financial crisis, can the bank operate without the State overview…

In India till now we have been using a pseudo bank based financial system. And we
are gonna argue that it is what India needs right now. India is not a perfect country; India’s
financial system has its flaws with all the scams we have had over the years. India uses its
banks (both private and public) to connect with the poor from giving subsidies to giving
discounted loans. It imposes many rules such as Repo rates, CRR, base rate, etc. to make sure
that the banks can withstand a financial crisis.

According to a Research Paper in World Bank, there are three main factors a country
needs to consider to make before choosing a financial system.

 Relationship between the Economic Development and the Stock Market Development
 How Robust is the legal framework to control the financial markets?
 Macroeconomic factors and determinants
As India’s stock market development is still in the nascent stage it won’t impede our
economic development, which is another major reason not to go with the market based
financial system. The legal frontier of the Indian financial is evolving with every scam. So,
we can comfortably say that its also in the development stage so no need to worry about the
market-based system where financial watchdog only overviews and does not interfere. India
macroeconomic determinants is very different from the rest of the world. As we are the only
nation whose constitution is still standing strong from the countries who got out from the
colonial rule. We have border disputes, we are surrounded by nuclear powered unfriendly
nations, we are susceptible to financial attacks from China as recently we saw in the HDFC
case, we have been to national emergency, we had our PM assassinated, and the list goes on.
So, it’s safe to say that India is not yet in the driving seat when it comes to the macro
economic factors which can shake our financial system altogether.

Yeah there are benefits in market based financial system but it’s may be for some
other developed country where the corruption is very low, where the stock market has its
penetration to 80% of the population, where the laws are very robust that the supply and
demand takes care of itself. Until India improves in these three factors, India needs to stick
with the bank based financial system.

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