Evolution of Financial Markets in India and Bank-Based Financing - A Study on Indian Manufacturing Firms

Abstract

Traditionally, India’s financial system is known as bank-based. However, the capital market development during the last two decades indicates a shift towards a more market-oriented financial system. While banks finance the working capital requirement of firms, primarily, capital markets complement the banking system by financing the longer term credit needs. As against the debate on whether stock market development in developing countries has translated to higher growth for these countries, several policy documents by the Reserve Bank have emphasised that growth in India would require both a robust banking system as well as a well-functioning capital market. Taking this cue, the paper makes an attempt to explore the impact of a changing financing system structure of India on the financing pattern of firms. Data and statistical analysis presented in the paper suggests that despite the stock and bond market development in recent years, banks are still a dominant source of finance for firms. This result points towards the importance of developing a vibrant corporate debt market as an alternative source of funds for Indian industry. Analysis of firm-level data suggests that while, for larger firms, the financing pattern remained broadly unchanged since liberalization, the smaller firms are increasingly moving towards other sources of financing, a major part of which represents inter-corporate borrowing.