As argued above, bank investments in equity constitute only one form of bank exposure to the stock markets. Advances against shares and guarantees to brokers provide other forms. But even on this count the RBI’s technical committee is quite positive. This is because: "The total exposure of all the banks by way of advances against shares and debentures including guarantees, aggregated Rs. 5,600 crore, comprising fund based facilities of Rs. 3385 crore and non fund based facilities, ie., guarantees, of Rs. 2,215 crore, as on January 31, 2001 and constituted 1.32% of the outstanding domestic credit of the banks as on March 31, 2000."
 
However, there is much that these figures conceal. To start with, the aggregate level of exposure across the banking system hides the fact that the "overall" exposure on the part of some of the private sector banks, whose "dynamism" has been much celebrated and used as the basis for privatization of public sector banks, has been far in excess of 5 per cent. As figures collated by the RBI’s Technical Committee reveal, at the end of 2000, the exposure to the stock market by way of advances against shares and guarantees to brokers stood at 0.5 per cent of total advances in the case of public sector banks, 1.8 per cent in the case of old private sector banks, 4.8 per cent in the case of foreign banks and a huge 15.3 per cent in the case of 8 new private sector banks. Thus, the so-called "dynamic" private banks which are seen as setting the pace for the rest of the banking sector, and are attracting depositors by offering them better terms and better services, are the most vulnerable to stock market volatility.
 
Secondly, this exposure of the banking system and of those that lead the pack in lending against shares, is dominantly to a few broking entities. The evidence on the relationship between Global Trust Bank and Ketan Mehta only begins to reveal what the RBI’s monetary policy statement describes as "the unethical ‘nexus’ emerging between some inter-connected stock broking entities and promoters/managers of some private sector or cooperative banks." The rot clearly runs deep and has been generated in part by the inter-connectedness, the thirst for a fat bottom line and the inadequately stringent and laxly implemented regulation that financial liberalization breeds.
 
Thirdly, the liquidity that bank lending to stock market entities ensures, increases the vulnerability of the few brokers who exploit this means of finance. Advances against equity and guarantees help them acquire shares that then serve as the collateral for a further round of borrowing to finance more investments in the market. These multiple rounds of borrowing and investment allow these broking entities to increase their exposure to levels way beyond what their net worth warrants. Any collapse in the market is therefore bound to lead to a payments shortfall, that aggravates the collapse, and renders the shares that the banks hold worthless and the advances they have provided impossible to redeem.
 
Finally, by undertaking direct investments in shares while providing liquidity to the market, the banks are further endangered. To the extent that the liquidity they provide encourages speculative investment and increases stock market volatility, any consequent collapse of the boom would massively erode the value of the banks’ own direct investments.
 
When all of this is put together, it is clear that the current level and pattern of exposure of banks to the stock market is itself worrying and the fact that this exposure has been increasing and may turn more pervasive is distressing. Banks are built on trust. As intermediaries they accept deposits from risk-averse savers, who are offered avenues of making relatively small investments in highly liquid financial assets characterized by low income risk, to fund large investments that are relatively illiquid and characterized by a high degree of capital and income risk. They are able to serve this role because of the belief that sheer scale allows them to cover costs, hedge against risk and honour their commitments.
 
Institutions such as these need to be shielded from the volatility of whimsical markets, because the fall-out of their actions can prove extremely adverse for small investors. It is possibly for this reason that the RBI technical committee on bank lending against equity, while holding that the basic framework of regulation need not change, recommends that the five per cent ceiling on bank exposure to stock markets must not apply just to direct investments in equity, but to all forms of exposure including lending against shares and guarantees to brokers.
 
But this small step in response to the recent crisis, may prove extremely inadequate. Five per cent of advances, while small relative to total bank exposure, is indeed large relative to the net worth and the profits of the banks. Major losses as a result of such exposure can therefore have devastating consequences for the viability of individual banks. This is an obvious lesson emerging from the recent crisis that calls for strong corrective action. But given its blind commitment to financial liberalization, India’s central bank appears reluctant to learn its lessons well.
 
The RBI is sanguine about the risk of bank exposure to capital markets because currently such exposure is well below this much relaxed ceiling. According to its Technical Comitteee set up to review guidelines regarding bank financing of equities, "The total investment in shares of the 101 scheduled commercial banks aggregated
 
Rs.8,771.60 crore as on January 31, 2001 and constituted 1.97% of outstanding domestic advances as on March 31, 2000 and was well within the norm of 5% of the domestic credit stipulated in the RBI Circular of November 10, 2000. The total investments in shares of all the banks aggregated Rs. 6,324.11 crore as on March 31, 2000 and constituted 1.42% of the domestic credit."