this is case developed he, for the student of economics and finance to give the insight on how financial innovations can lead economic consequences

1. Financial innovations and emerging markets
A recent case of recapitalization scheme of state own banks in
India
Evidence from India
By Muhammad Bilal
2017

2. Introduction
Financial innovations (the act of creating and the popularizing new financial instrument
technology institutions and markets) are always considered the risky way of economic growth, we
look at the reasons for global financing crisis one of the main reason was financial innovation like
(derivatives in finance, a derivative is a contract that derives its value from the performance of an
underlying entity. This underlying entity can be an asset, index, or interest rate, and is often simply
called the "underlying"). Although during the crisis the most suffered countries were developed,
however, the aim of the study is to review what is impact of financial innovations on the emerging
markets (country that have some characteristics of developed country but does not meet the
standards for the developed countries) what are innovation’s in the state own lenders they are often
considered the political stunts that are done by Politician to gain political fame some of them are
subsidize lending, loans are given without proper credit appraisal. Since the beginning of the 21
century, the Indian financial industry started financial innovation’s many new financial institutions
were developed to energize the economy at the same time state own banks were encouraged to do
the same and the beginning 21century marked the start of innovation’s in-state own banks of India
which would, later on, become the biggest economic hurdle for the government of India.
Background
On the 24 October, Indian finances minister announced one of the biggest recapitalization schemes
of human history 2.11trillion which will be generated in two-way process 1.37 trillion in
recapitalization bonds and the rest will be generated through budgetary allocations and fundraising
through market, however this scheme was announced for the state own lenders weighed down by
bad debt seeking to energize the economy through private investment. The reason behind the deal
was decaling growth rate which was 5.6 for the quarter ended June the lowest in three years.
Considering the fact that India is emerging market and wants to achieve economic growth but why
do we recapitalize what is the need for recapitalization following are the questions that need to be
answered banks have some constraints which can stop them from lending the that is the capital
ratio for every loan that’s a bank make it have to keep 10%as capital so if the banks have the 100
rupees it can lend 1000.Now consider if bank loss 50 rupees’ in loan that was given to someone
who defaulted now banks have only 50 rupees as capital so it can make loan of 500 rupees, this

3. was the problem with Indian state own banks the bad debts caused the bank capital ratio to fall and
its ability to lend to the investor especially to small firms was limited, this was actually a bailout
package to rescue the declining growth rate which the Indian government wants to achieve but the
question is at what at cost there are two parts to this deal one increasing the capital ratio by
recapitalization of the banks and second is budgetary allocations, and fund raising through markets
how will this be done by Indian government which is already facing the current budget deficit of
500,000 crores for the fiscal year 2017 this will worsen the situation for the government. Following
are the few innovate scheme that were offered by state-own lenders in India from last fifteen years
working capital loan offered to people for their day to day business operations corporate terms
loans terms loans many other loans were offered by the state own lenders but the credit appraisal
system and rules were relaxed and the outcome was disastrous for both the banks and government.
There are many aspects of this problem, one financial innovation in emerging markets often proves
to be the disastrous for the economy, because emerging markets economies are very different than
the developed economy, where if there is any financial innovation fails in developed economy
government can support that without having too much impact on the fiscal budget.Second, the
attitude of the population in emerging market towards economic growth quite different than
population attitude in a developed economy.third, government policy towards economic
development, in this case, it proofed disastrous.Every policy made by the government in emerging
markets doesn’t also mean to achieve economic growth some are meant to achieve political
interest. There are reference cases of recapitalizations from past, for example, Algeria government
issued recapitalization bonds in 1992-92 reason “purchasing bad assets”, similarly 1996
“purchasing bad assets, Korea 1998” purchase bad assets “Malaysia “to finance the purchase of
bad assets” Mexico 1995 “purchasing bad assets” Poland 1993 “to cover the bank loses” and the
list goes on and we find that most of the countries that have used recapitalizations are
developing/emerging. The above mention fact gives us an evidence that, whenever government
tries to innovate in financial sector through its different loan schemes, financial product will tend
to have disastrous effect on the economy

4. Solutions
What is the solution to this problem? Recapitalization its self is considered a solution to this
problem. A retrospective of the recapitalization scheme gives inside to the story that this is
considered to be the solution for funding “bad assets purchase by government”. There two
consequential aspects of recapitalization short and long-term in this case if look at long-term
consequential aspect which the Indian government have to bear on fiscal deficit, so what is the
solution then, as mention above political decision in developing/emerging markets are often based
on how to gain political fame rather, then economic goals based on economic aspect so this needs
to be changed. Second population attitude towards economic growth in developing/emerging
markets needs to be changed through awareness. Third privatization of state owns lenders the
retrospective of privatization gives us the positive relationship between the performance of state
own banks that were privatized, for example, subrata& Rudra (2010) in their study found that
partial privatization of state own lender in India improved the financial performance. according to
Sana &samreen (2015), that privatization has a positive impact on the bank's performances in
Pakistan. Fourth credit appraisal methods for the innovative scheme should be revised and
improved. Mention above are some of the solutions to the problem.
Conclusion
The aim of the study was to examine that how financial innovation in the emerging market impact
the economic growth. Financial innovation can lead to economic growth, but it is for the short
time, however in long term it can have disastrous effect on the economy of the country.
Recapitalization is often uses as solution to finance bad assets or purchase bad assets. So based on
the above mentioned examples we conclude that in developing economy/emerging markets
privatization of state own lenders or any other state own enterprises tend to improve the financial
performance, because under the public proprietorship there are many obstacles that imped these
enterprises from performance. So we conclude that financial innovation in the emerging markets
also fail, and the economy have to bear consequential effect. So we suggest from our results that
emerging markets should avoid financial innovation, because their economies are very fragile.

5. References
Micheal Andrew (2004) Issuing Government Bonds to Finance Bank Recapitalization and
Restructuring design factor that affect banks financial performance IMF policy discussion paper
Subrata Sarkar, Rudra Sensarma, (2010) "Partial privatization and bank performance:
evidence from India", Journal of Financial Economic Policy, Vol. 2 Issue: 4, pp.276-306,
Sana Siddiqui and Samreen Lodhi(2015) Impact of Privatization on Firm’s Performance: A Case
of Banking Sector of Pakistan ISSN: 2321-3124