Evolution of Indian Financial System

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Evolution of Indian Financial System: A Critical Review
The Economic Development of a country depends, inter alia, on the financial system. The larger the proportion of the financial assets (money and monetary assets) to real assets (physical goods and services), the greater the scope for economic growth in the long run. For growth to take place, investment is necessary which flows from the financial system. Besides, as a scarce factor of production in the Less Development Countries (LDCs), finance has a crucial role to play in these economies. The growth objective of the financial system is to achieve the structure and rate of growth of various financial assets and liabilities in consonance with the optimal characteristics of real capital stock. The more efficient composition of real wealth is obtained through the promotion of such financial assets which provide incentives to savers and the public to hold a growing part of their wealth in financial form. Increasing rate of savings correlates well with the increase in the proportion of saving held in the form of financial assets relative to tangible assets. There is a direct correlation between growth of the economy and the growth of the financial assets. Investment in the real sector depends on the functioning of the financial sector, as the latter collects and channels saving into investment which is necessary for growth. It would be pertinent to note here that economic growth is function of the level of investment, capital-output ratio in each activity of productive process, the level of investment, determines the increase in output of goods and services and incomes in the economy. The Indian financial system is undergoing a sea change in response to the changes that have been taking place in the social, political and economic environment and in the process laying a sound edifice for a vibrant economy.

The Indian financial sector comprises a large network of commercial banks, financial institutions, stock exchanges and a wide range of financial instruments. It has undergone a significant structural transformation since the initiation of financial liberalization in 1990s. Before financial liberalization, since mid 1960’s till the early 1990’, the Indian financial system was considered as an instrument of public finance (Agarwal, 2003). The evolution of Indian financial sector in the post independent period can be divided in to three distinct periods. During the first period (1947-68), the Reserve Bank of India (RBI)consolidated its role as the agency in charge of supervision and banking control (Sen & Vaidya, 1997). Till1960’s the neo-Keynesian perspective dominated, argued interest rates should be kept low in order to promote capital accumulation (Sen & Vaidya, 1997). During this period Indian financial sector was characterized by nationalization of banks, directed credit and administered interest rates (Lawrence & Longjam, 2003). The second period (1969 - mid 1980’s), known as the period of financial repression. The financial repression started with the nationalization of 14 commercial banks3 in 1969. As a result interest rate controls, directed credit programmes, etc. increased in magnitude during this period (Sen & Vaidya,1997). The third period, mid 1980’s onwards, is characterized by consolidation, diversification and liberalization. However a more comprehensive liberalization programme was initiated by the government of India during early 1990’s.The impetus to financial sector reforms came with the submission of three influential reports by the Chakravarty Committee in 1985, the Vaghul in 1987 and the Narasimham Committee in 1991. But the recommendations of the Narasimham Committee provided the blueprint of there forms, especially with regard to banks and other financial institutions. In 1991, the government of India initiated a comprehensive financial sector liberalization programme....
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