ABSTRACT
We seek to evaluate how far a conventional (AIDS)model can explain the portfolio behaviour of Indian commercial banks, particularly in the context of the various financial and regulatory constraints to which banks were subject, including the nationalisation of major banks and subsequent financial liberalisation. Regulations imposed on the banking sector, such as administered interest rates,
mandatory high reserve requirements (both for cash and liquid assets) and a directed credit programme are closely associated with fiscal devices, and they have repressed the banking sector in India with respect to its efficiency and profitability. The banking sector is, however, believed to be the principal institution for providing loanable funds to non-financial private sectors, and bank financing is a prime external source of funds for them, due to the under-developed securities market and the costliness of moneylenders in India. Therefore the study of the asset choice (or a flow of funds) in commercial banks will bring out crucial policy implications for economic activities. The rest of the chapter is organised as follows. Section 5.2 gives the institutional
background, outlining bank regulations and the general conduct ofmonetary policy in the pre-and post-financial reform eras since Independence. The AIDS model and its rationale in the present context are set out in Section 5.3. In Section 5.4 we describe the data and explain the classification of assets and liabilities used in the model. Empirical results are set out in Section 5.5, where we give unit root and co-integration tests, a range of diagnostics, and estimates of general and specific models with theoretically acceptable economic restrictions imposed and tested. Section 5.6 draws conclusions from this empirical work.
