Flawed tax system Comparison with an ideal regime Details of current tax regime Defects in the present tax system Effets of the tax regime Weak banking system Current economic affairs and trends Globalization and it's impact

Weak banking system

Expectations of a good banking system

The role of banking system can be compared to the circulatory system within the human body. Just like the blood vessels carry the essential nutrients to all the parts of the human body, the banking system is expected to supply the "money capital" to the all the individuals and the institutions.

Role of Capital in the economy is like that of the blood in the human body. As the blood carries the required nutrients to the individual cell, capital promotes productivity in the economic system.

Any disorder in the circulatory system leads to disease in the entire body. Similarly, a flawed capital creation and distribution system has an equally debilitating effect on the economic system.

A look into Generation of Money

Coin Money: Coins up to Rs. 5 are minted by Government treasuries as per government directives. This does not need any security.

Currency Money: The Reserve Bank of India, brings into circulation, currency notes backed by security of - either the Central Government Securities or the foreign exchange reserves.

Bank Money / Demand Deposits: Money generated due to credit expansion is Bank Money.

Understanding Credit Expansion

Let us try to understand credit expansion via an example

Suppose a bank "A" has a deposit of Rs. 2000 in the name of a person P. Assuming a minimum cash reserve ratio of 10%, the bank will keep Rs. 200 towards this cash reserve requirement and create derivative deposit to the extent of Rs. 1800, which represents the excess reserves with the bank.

It is these excess reserves that the bank uses to give loans and advances to its customers. Let us say the borrower, Mr. M, in repayment of some business obligation gives the cheque of Rs. 1800 to Mr. N who has a deposit account in a bank "B". Bank B now receives Rs. 1800 and can give Rs. 1620 as loan/advances.

Continuing the process likewise, we can see with the help of the table below, that the original primary deposit of Rs. 2000 results in creating a derivative deposit of Rs. 18,000, which is ten times of the original excess reserves of Rs. 1800.

Multiple Expansion of Credit through Banking System

A higher cash reserve ratio would lead to a lower Credit multiplier* and vice versa.
*Credit Multiplier = Volume of Derivative Deposits / Original Excess Reserve

In our example this would be 18000/1800, i.e. 10

Present scene: A statistical look

As per the data available on money supply, from the web site of the RBI (www.rbi.org.in),

Currency Money = Rs. 2,65 325 Crores

Bank Money = Rs. 1,85, 232 Crores

The figures clearly tell that the bank money is less than the currency money. Because bank money itself is scarce, money itself has become the most valued commodity and everyone is after Money. The economy forever faces a scarcity of money.

This naturally leads to a market, which is driven, by "affordability" rather than "quality". In the globalization era, Indian goods and services thus always suffer in comparison.

Reasons for this state of affairs

The key causes for the current state of the banking system are

• Ease of cash transactions due to the availability of high denomination currency notes
• A flawed tax system compounding the situation by encouraging tax evasion and thereby leading to generation of more black money
• Out of the total transactions happening in the economy only a small percentage is routed through the banking system
• The number of customers having Credit History is very small
• Ever shifting economic and banking policies of the government lead to everyone preferring cash transactions rather than banking transactions