Impact of financial and capital market reforms on corporate finance in India

India’s financial and capital market reforms since the early 1990s have had a positive impact on both the banking sector and capital markets. Nevertheless, the capital markets remain shallow, particularly when it comes to differentiating high-quality firms from low-quality ones (and thus lowering capital costs for the former compared with the latter). While some high-quality firms (e.g., large firms) have substituted bond finance for bank loans, this has not occurred to any significant degree for many other types of firms (e.g., old, export-oriented and commercial paper-issuing ones). This reflects the fact that most bonds are privately placed, exempting issuers from the stringent accounting and disclosure requirements necessary for public issues. As a result, banks remain major financiers for both high- and low-quality firms. The paper argues that India should build an infrastructure that will foster sound capital markets and strengthen banks’ incentives for better risk management.