Bank Depositors' Role as a Disciplinary Force in Indian Banking: A Dynamic Panel Approach

26 Pages Posted: 18 Jan 2009

See all articles by Abhijit Sarkar

Abhijit Sarkar

Indian Institute of Technology (IIT), Gandhinagar - School of HSSM

L. M. Bhole

Indian Institute of Technology (IIT), Bombay - Department of Humanities and Social Sciences

Date Written: November 25, 2008

Abstract

The New Basel Capital Accord recognises that market discipline (Pillar III) has the potential to reinforce minimum capital standards (Pillar I) and the supervisory review process (Pillar II), and so promote safety and soundness in banks and financial systems. A number of studies in the context of developed financial system find support for this complementary relationship. However, one important question that can be raised in this context is the extent to which market can be relied upon to act as an effective disciplinary force in the immature financial markets dotting the developing economies, including India. This paper addresses this issue by examining the behaviour of the bank depositors in India. More specifically, it attempts to ascertain whether depositors respond to changes in bank fundamentals, both in terms of deposit held with a bank as well as interest received on it. Considering that a bank's ability to change interest rates (in addition to bank fundamentals) may also influence depositors' willingness to hold deposit with the concerned bank, a possibility arises that depositors' reaction and banks' response (in terms of interest rate payable on deposits) may be a jointly determined process. To account for this dynamic process, the Arellano-Bond dynamic panel generalised methods of moments (GMM) estimation method is employed. The results fail to find any significant evidence of discipline being exerted by the bank depositors. This highlights the limitations of relying on market forces as a disciplinary mechanism in cases of underdeveloped financial systems and the necessity to maintain a high capital standard as well as a vigilant and strong supervisory process.

Keywords: Basel II, Market Discipline, Bank Depositors, Dynamic Panel

JEL Classification: G21, G28

Suggested Citation

Sarkar, Abhijit and Bhole, Laxman Madhao, Bank Depositors' Role as a Disciplinary Force in Indian Banking: A Dynamic Panel Approach (November 25, 2008). Available at SSRN: https://ssrn.com/abstract=1329196 or http://dx.doi.org/10.2139/ssrn.1329196

Abhijit Sarkar (Contact Author)

Indian Institute of Technology (IIT), Gandhinagar - School of HSSM ( email )

Visat-Gandhinagar Highway
Chandkheda
Ahmedabad, Gujarat 382424
India
00919099010523 (Phone)
00917923972622 (Fax)

HOME PAGE: http://www.geocities.com/ovi.sarkar

Laxman Madhao Bhole

Indian Institute of Technology (IIT), Bombay - Department of Humanities and Social Sciences ( email )

Bombay
IIT Bombay, Powai
Powai, Mumbai, ND
India

HOME PAGE: http://www.hss.iitb.ac.in/bhole

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