ABSTRACT
In this chapter, portfolio behaviour of other financial institutions (OFIs) in India, consisting of term lending institutions, insurance companies and unit trusts and mutual funds, is modelled. The aim is to assess to what extent the OFIs can contribute to the resourcemobilisation and how far the policy can have an influence on an economy in the intermediation of this sector in India. In the financial liberalisation, following the recommendation of the
Narashimham committee in 1991, there was a gradual shift to the market-related rate on government borrowing, and the de-regulation of lending and deposits rates was almost completed in 1997. These de-regulated interest rates were intended to activate open market operations as the principle instrument of liquidity management in India, and to vitalise the role of the Bank rate as a signalling device to the market rates. In the transitional period from the administered to de-regulated interest rate regimes, it is important to identify how financial intermediaries respond to interest rate changes in their asset choice, and how the resources are re-allocated, in the formulation of appropriate economic policies. The empirical focus is to address the impact of interest rates on the resource allocation in order to measure the policy dimensions with respect to the portfolio behaviour, of OFIs. This is to our knowledge, the only OFIs sector-specific portfolio model for any
developing country. In general, relatively few portfolio studies have been done for developing countries. If any, applied literature has largely neglected the asset decisions of OFIs, though theymay possess important implications in an economy. In typical applications the concentration is on a banking sector, or on the whole private sector including households, corporate and financial firms being treated as a single entity because of a lack of suitable disaggregated data (Sen et al. 1996 and Adam 1999). This chapter is organised in the following manner. The flow of funds in OFI
is explained in Section 6.2, where the aggregate balance sheet and the flow data are spelled out. Section 6.3 sets out the AIDS model specification. The empirical results for long-run model are found in Section 6.4. Some concluding remarks are contained in Section 6.5. (See Section 3.2 in Chapter 3 for some specific
4 for specification and the econometrics methodology.)
The role of the OFIs on credit allocation is perhaps measured by comparing it with the banking sector in India. See Figure 6.1, where the proportion of loans from banks and OFIs to the total loans for household and non-financial corporate sectors is shown respectively. The effect of the lending directions is featured by the proportionate rise in bank credit to the household sector at the end of the 1960s (Figure 6.1a), indicating the increased lending towards the priority
the corporate sector, as is evidenced that in Figure 6.1b for the corporate sector, bank credit is predominant until around the early 1970s, when it was gradually reduced. A dramatic fall in the end of the 1980s is probably due to the fact that there was a sharp increase in the CRR and SLR in order to finance the substantial fiscal deficit in the government sector. This is contrasted with the flow of credit from OFIs towards firms, which steadily increased over the sample period, and after mid-1980s the loans from this sector exceeded those from banks. The role of banks as major lending institutions to the corporate sector may be losing their prime position to the OFIs. This has significant implications for the formulation of the economic policy and the effect that the policy may have on such shifting intermediation in the post-reform period. The aggregate balance sheet for the OFIs sector is set out below
Liabilities: Provident Fund
Net assets: Company Securities less Share Capital Loans and Advances less Bonds and Debentures Government debt
Liabilities equals net assets. The holdings of cash, deposits and foreign assets are negligible, hence excluded. Share capital, which includes paid-up capital and unit trust capital, and bonds and debentures in sources are netted out from company securities and loans and advances in uses respectively, thereby the liability consists of only Provident Funds (which include provident, life and pension funds). The interest rate controls meant that OFIs could not bid for the provident funds by changing interest rates. Also note that in India there are substantial compulsory insurance schemes and the contractual nature of the funds implies inflexibility with respect to portfolio choice. The supply of provident funds was therefore outside OFIs’ control, being demand-determined. With respect to other liabilities, equity or debt finance are more likely to be the OFI’s choice; the OFIs hold either share capital or bond and debentures depending on the interest rates,2 or on such differences as the term structure, tax treatment and the risk characteristics. The composition of the net assets is therefore considered as being the OFIs’ choice, whereas the total of them (i.e. the provident funds) are not. We model net assets (assets less liabilities) to define the portfolio behaviour of OFI.3
