Narrow banking

Definition:
Narrow banking refers to a banking model where banks limit their lending activities to risk-free sectors. This approach is aimed at reducing the risk of banks and increasing financial stability.

Explanation:
Limited areas of operation by banks:
- One way to ensure financial stability is by restricting the areas of operation of banks. Narrow banking suggests that banks should only engage in low-risk activities, such as lending to risk-free sectors.
- By limiting their lending activities to risk-free sectors, banks can reduce the likelihood of defaults and minimize the impact of financial crises.

Banks lending only to risk-free sectors:
- The concept of narrow banking suggests that banks should only provide loans to sectors that are deemed to be safe and less prone to default.
- Risk-free sectors typically include government securities, highly-rated corporate bonds, and other low-risk assets.
- By focusing on lending to risk-free sectors, banks can minimize their exposure to default risk and ensure the safety of customers' deposits.

Banks acting only as payment banks:
- Narrow banking is not the same as banks acting only as payment banks. Payment banks primarily focus on providing basic banking services, such as accepting deposits and facilitating transactions, rather than engaging in lending activities.
- While narrow banking advocates for banks to limit their lending activities, it does not necessarily imply that banks should solely act as payment banks.

Banking by non-banking financial companies:
- Narrow banking is not synonymous with banking by non-banking financial companies (NBFCs). NBFCs are financial institutions that provide banking services without holding a banking license.
- Narrow banking refers specifically to the lending activities of traditional banks and the need to restrict lending to risk-free sectors.

In conclusion, narrow banking is a concept that suggests banks should limit their lending activities to risk-free sectors to enhance financial stability. It does not imply that banks should solely act as payment banks or that non-banking financial companies should engage in banking activities.