REGULATION OF BANKS’ CAPITAL AND MACRO-STABILITY — A THEORETICAL APPRAISAL
Description
Following the adoption of the New Economic Policy (NEP) by India in July 1991, Government of India (GOI) has started viewing banks as commercially organized profit driven financial institutions whose viability depends upon their ability to make profit. Like all capitalist economies, India is also subject to trade cycles and onset of a recession leads to a drop in banks’ profit levels and an increase in their stock of non-performing assets. This prompts the government to ask banks to tighten lending norms and maintaining adequate capital buffer as mandated by minimum capital requirement norm. This paper develops a simple baseline model to examine the implications of this kind of a policy. It shows that the policy noted above deepens recession, increases inequality and exacerbates the problem of non-performing assets and lowers profit. It also shows that, instead of taking the banks and the defaulting firms to task for a factor that is completely beyond their control, the best way of tackling this problem is to adopt appropriate stabilization programmes to counter the recession.