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 (Table 1), 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.
Table 1 >>
 
When it comes to non-performing assets (NPAs), however, the differentials seem to point in a completely different direction. As Table 2 shows, the ratio of NPAs to total assets was higher in the case of the older public sector and private sector banks, and were lower in the case of the new private sector banks and the foreign banks, most of which are new entrants into the banking scene in India. But these differences are more because of the effects of age, with the older banks having over the years accumulated such NPAs at a slow pace, and not having been subjected to provisioning and prudential norms of the kind that have been put in place after the process of liberalisation began. Corrective measures launched recently have begun to reverse these high NPA ratios.
Table 2 >>
 
What would be more crucial is to assess whether, in recent times, the rate of increase of NPAs has tended to be faster among the private sector banks that have a greater exposure to sensitive sectors in general and the capital market in particular. Adequate evidence to make such an assessment is not available yet. But there is some evidence to that effect. Thus, Nedungadi Bank, which was one of those with a high exposure to capital markets has seen an increase in the ratio of its gross NPAs to asssets from 4.6 per cent in 1996-97 to 8.4 per cent in 1999-2000, and market rumours have it that the ratio would have gone well into the double-digit range after the recent stock market collapse.
 
However, till the recent collapse, the fact that the exposure of banks to the stock market has not on average been too high, has encouraged the RBI to be lax with regard to restricting the movement of banks into such ‘sensitive' activities. Till very recently, RBI guidelines regarding bank exposure to the stock market applied only to direct investment in shares. Even these had been substantially relaxed not too long ago. According to guidelines issued in October 1996, when banks were being encouraged to investment in stocks as part of the process of financial liberalization, banks were permitted to invest up to 5 per cent of their incremental deposits in the previous year in stock markets. Initially, investments in debentures/bonds and preference shares were included within this five per cent ceiling. However, as stock market performance was increasingly accepted as an indicator of the success of reform, and the government was under pressure in 1997 to revive flagging markets, it sought to encourage banks to invest more in the markets. This was done, in April 1997, by taking debentures/bonds and preference shares out of the calculation of the limit. This made the ceiling only relevant for investment in equities. Further, the 5 per cent ceiling on investments in equity shares was to include loans to corporates to help them meet the promoters' contribution to the equity of new companies. That is, banks could provide "bridge finance" against shares, for companies planning to raise resources from the market for new projects, on the expectation that the loan will be repaid when such resources are raised.
 
In an associated move, the minimum maturity on commercial paper issued by corporates was brought down from 3 months to 30 days, allowing them to use such instruments for extremely short term accommodation. The net result of all this was a substantial increase in the flexibility banks enjoyed with regard to making ‘corporate' investments, especially in financial instruments that are known to be risky.