Concept of Narrow Banking

Before we move ahead, just give a thought to this question:

Consider the following statements:

1. In Narrow Banking, Banks just accept deposits and provide loans.
2. In Narrow Banking, there is rarely Asset Liability Mismatch.

Which among the above statements is / are correct?

In the above question, only statement 2 is correct. The Narrow Banking is very much an antonym to the Universal Banking. In Narrow Banking, the Bank places its funds under the risk free assets and the maturity of the liabilities match the assets and there is No possibility of the Asset Liability Mismatch.

• Narrow Banking means Narrow in the sense of engagement of funds and not in activity.

So, simply, Narrow Banking involves mobilizing the large part of the deposits in Risk Free assets such as Government Securities. Now, please note the following:

• Banks in India partially implement the Narrow banking.
• The RBI prescribes a 25% SLR ^{Statutory Liquidity Ratio,} but Banks invest much more than that in Government securities which provides them a low return.
• The Government securities have a 0% risk weightage and the Government approved Securities have a risk weightage of 2.5% , compared to the loan assets which have around 50-75%.
• Narrow Banking, in Narrow sense helps the Banks to reduce the Non Performing Assets (NPA) as the engagement brings them some returns also.