Financial Intermediation in India: A Case of Aggravated Moral Hazard?

After extensively reviewing developments in the Indian financial sector, the paper attempts an explanation of the currently observed economic slowdown in terms of weaknesses in financial intermediation in India. The weaknesses emanate from a large and increasing government role in the financial sector. Together with high regulatory forbearance and an absence of efficient bankruptcy procedures, the outcome is an endogenously evolving aggravated moral hazard, which progressively dilutes effective co-financing and, consequently, has the potential of reversing the rate of capital formation. The paper constructs indices that capture changes in effective co-financing and density of government involvement for the last ten years.