Bank Financing in India∗

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 (Burgess and Pande, 2003). 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 non-performing (NPA) and that they under-lend, in the sense of not putting enough effort into their primary task of financing industry (Narasimhan committee, Government of India, 1991). A wide range of remedies have been suggested ranging from strengthening the legal system to punish defaulters, to abolishing the targeted lending programs (the so-called priority sector rules), to privatization of the entire banking system. Many of these recommendations have been controversial, partly because there is relatively ∗This research would not have been possible without generous assistance from several parties. We thank the Reserve Bank of India, in particular Y.V. Reddy, R.B. Barman, and Abhiman Das, for generous asssitance with technical and substantative 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 study for allowing us access to their data. We gratefully acknowledge financial support from the Alfred P. Sloan Foundation. 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. †Department of Economics, MIT ‡Department of Economics, MIT, NBER, and CEPR