Market Discipline in Post- Transformation Era: A Study on Banking Sector

This paper attempts to investigate the existence of Market Discipline in the Indian commercial banks over the period 2001-2008 i.e., 7 years. This period is characterized by second round of banking sector reform as suggested by Narsimham Committee for banking restructuring and market discipline. A total of 63 scheduled commercial banks were taken as the sample size which included 27 public sector banks, 23 private banks and 13 foreign banks. Two dependent variables viz. total deposits held by banks and interest paid on deposits to total deposit ratio are considered in this study. We hypothesize that the dependent variables in this study, which signifies the existence or otherwise of market discipline depends on three sets of variables: a) bank-specific; b) banking industry level; and c) macroeconomic. The findings show that while bank-specific factors, and in particular, policy variables, in addition to bank-specific indicators tend to be dominant in case of private banks. For foreign banks, the macroeconomic conditions tend to overwhelm bank-specific factors in explaining behavior of depositors. This provides testimony of market discipline in the banking sector in India.