Portfolio behaviour of Indian commercial banks

Abstract

In allocating their funds the commercial banks have to fulfil a number of legal restrictions. The increasing nature of the restrictions has reduced the freedom of the banks to operate on their portfolio. Despite this it seems desirable to study the portfolio behavior of banks, because an analysis of the data of individual banks shows variations in their asset holdings.

This dissertation is concerned with studying the portfolio Behavior of the Indian scheduled commercial banks over the period 1960-1975. The study has been attempted at two levels, a) for the banking system and b) for the individual banks.

The econometric model has been able to explain reasonably well the portfolio behavior for both the banking system and the individual banks. In the case of the aggregate system, the variables that significantly explain the behavior are market interest rates, the disposable level of funds and the increase in loans and deposits.

The same set of variables explains the portfolio behavior of individual banks as well but their coefficients differ significantly across banks. An analysis of the coefficients suggested three bank groupings namely those of State Bank and its subsidiaries, the nationalized banks and the private sector banks. However in order to better bring out the impact of bank specific variables such as size and liability structure a cross sectional analysis has a significant impact in portfolio choice, but the size variable has a significant impact only in the case of cash and investment in government’s securities.

The model has been able to forecast well beyond the sample period considered. The model was quite successful in forecasting in the case of loans and government securities but was not as successful in the case of excess reserves and borrowings. The effect of nationalization of banks on their portfolio behavior has been examined by splitting the data between 1960-1975 into two periods prior to nationalization 1960-1968 and after nationalization 1969-1975. No significant change was found in the behavior before and after nationalization.

An optimization model of bank portfolio allocation taking into account the legal and other constraints on the bank operations has been attempted. This exercise was of an exploratory type and it was only an attempt to demonstrate the use of linear programming for management of bank funds.

The econometric model provides implications for monetary policy and can be used to evaluate alternative policy options. The banks do not have much freedom on their portfolio but within the freedom available the banks can concentrate on cash management and maturity mix of the securities over which they have freedom in order to improve their earnings.