Though there is some talk of bank funds finding their way into the country's capital markets, the exposure of the sector remains way below that permitted by the Reserve Bank of India.

As compared to the 5 per cent of total assets that banks are allowed to invest in capital markets (the figure's 8 per cent for HDFC Bank [Get Quote]), the average for the banking system in 2004-05 was a mere 0.2 per cent.

Indeed, the total capital market exposure of Rs 4,782 crore (Rs 47.82 billion) in 2004-05 was just a little over two per cent of last year's growth in non-food credit. If senior bankers are to be believed, there may not be any radical change in banks' exposure to the capital market despite the Bombay Stock Exchange sensitive index crossing the 8,500 mark.

This is because public sector banks, which account for the largest chunk of the banking industry, are risk averse and hardly have any expertise to play in the market.

A glaring instance is State Bank of India [Get Quote]. The largest commercial bank in the country, which roughly accounts for one-fourth of the banking industry, raised its exposure to the capital market nearly five-fold last year but that still took the total to a mere Rs 129.36 crore (Rs 1.293 billion), or a mere 0.03 per cent of its total asset base of Rs 4,60,000 crore (Rs 4,600 billion) in 2004-05.

None of the Indian banks had four-digit exposure to the capital market last year. HDFC Bank had the highest exposure -- Rs 984.63 crore (Rs 9.846 billion). Only two other banks had over Rs 500 crore (Rs 5 billion) exposure to the capital market last year. They are Bank of India (Rs 704.48 crore) and ICICI Bank [Get Quote] (Rs 668.36 crore).

Despite this, however, the RBI has asked banks to monitor the end use of funds disbursed to corporations since it is possible that while banks are not lending directly to the capital markets, loans extended by them to clients are finding their way back to the markets.

The regulator suspects that a few co-operative banks may have disbursed funds to their clients which found its way to the market. Similarly, a few non-banking finance companies may have taken bank loans or raised short-term money from the market in the form of commercial paper to play in the market.

However, so far the central bank has not found any instances of fund diversion or banking funds flowing into the capital market.

A cautious RBI raised the risk weight for banks' capital market exposure in July from 100 per cent to 125 per cent. The banking sector's capital market exposure covers direct investment by a bank in equity shares, convertible bonds and debentures and units of equity-oriented mutual funds; advances against shares to individuals for investment in equity shares (including IPOs and ESOPs), and secured and unsecured advances to stock brokers and guarantees issued on behalf of stock brokers.

An individual's bank borrowing limit for investment in equity shares is capped at Rs 20 lakh (Rs 2 million). In case of any decline in share prices, an individual is required to bring in more funds to maintain the margin requirement.

Despite all these safety valves, however, the regulator is not taking any chances since the nightmares of the Madhavpura Mercantile Co-operative Bank, Global Trust Bank and Nedungadi Bank are still fresh in public memory.

Madhavpura's capital market gamble not only wiped out its entire net worth but also over 96 per cent of its deposit base. Its exposure to the sharebrokers and their associates was over Rs 1,100 crore (Rs 11 billion) or 68 per cent of its advances.

Along with Madhavpura, at least 25 urban cooperative banks lent funds to stock brokers in violation of prudential norms.

With slow credit offtake and no avenues to deploy their funds, Nedungadi and GTB took the easy way out to make a fast buck. While GTB ended up taking huge exposures to a stock broker, Nedungadi was found guilty of violating arbitrage norms. It wanted to make a killing on the price differences of shares on the Bombay Stock Exchange and National Stock Exchange -- a forbidden activity.

What's more, the RBI even found that a string of brokers were holding a substantial stake in the bank that had given loans to companies fronted by the brokers. Nedungadi was merged with Punjab National Bank [Get Quote] and GTB with Oriental Bank of Commerce [Get Quote]. Madhavpura is still in a coma.

Till the early 1990s, banks needed to get the RBI nod for any loan above Rs 5 crore (Rs 50 million) under the credit authentication scheme.