Indian financial system

What follows is my understanding of a May 2006 McKinsey report on Indian financial system reform:


This report asserts that Indian financial system is inefficient, and it does not allocate capital efficiently i.e. to its most productive uses.

Indian financial depth is low as compared to other Asian nations. This means that India has 160% of GDP as financial assets.

Breakup as a % of GDP as of 2004:

1. Equity: 56
2. Corporate debt (Through Bonds): 2
3. Govt debt: 34
4. Bank deposits: 68

This is as of 2004. Today (2007) the equity is about 100% of GDP. So financial depth has probably increased to about 200%. In comparison, Japan and Singapore have 400% financial depth.

Another aspect that is different about India is its low corporate debt. Hence, companies have to rely upon banks for loans.

Indians are also world's largest gold consumers and these money could be channelled into more productive uses.

Most of the savings go into govt priority projects. Banks are obliged to hold 25% of their assets in govt bonds. Govt policies require banks to direct a big chunk of loans to agriculture and other priority sectors.

Indian banks only lend out about 60% of their deposits. This number is about 100% for UK and US.

Much of the banks funds go to fund the total govt deficit (including states). This is about 12% of the GDP!

Indian corporate bond market is just 2% of GDP because of several reasons:

1. High issuance costs due to complex regulation
2. Lengthy listing procedures
3. High disclosure requirements
4. Inadequate credit risk rating system
5. Inadequate dispute resolution mechanisms.

Hence, these banks avoid the hassles. They go for pvt placement, international bonds or bank loans. These bank loans crowd out smaller players who need funds to grow. [May be this is why PE is booming in growth capital in India ].

If these inefficiencies are removed, India can grow even faster!!