Financial sector reforms

• From the 1991 India economic crisis to its status of

third largest economy in the world by 2011, India has
grown significantly in terms of economic development.
• So has its banking sector. During this period,
recognizing the evolving needs of the sector, the
Finance Ministry of Government of India (GOI) set up
various committees with the task of analysing India's
banking sector and recommending legislation and
regulations to make it more effective, competitive and
efficient.
• Two such expert Committees were set up under the
chairmanship of M. Narasimham.
 Financial sector reforms

• They submitted their recommendations in the 1990s in

reports widely known as the Narasimhan Committee-I
(1991) report and the Narasimhan Committee-II (1998)
Report.
• These recommendations not only helped unleash the
potential of banking in India, they are also recognized as a
factor towards minimizing the impact of global financial
crisis starting in 2007.
• Unlike the socialist-democratic era of the 1960s to 1980s,
India is no longer insulated from the global economy and
yet its banks survived the 2008 financial crisis relatively
unscathed, a feat due in part to these Narasimham
Committees
First Narasimhan Committee Report – 1991

• To promote the healthy development of the financial

sector, the Narasimhan committee made
recommendations.
• 1. Establishment of 4 tier hierarchy for banking structure
with 3 to 4 large banks (including SBI) at the top and at
bottom rural banks engaged in agricultural activities.
• 2.The supervisory functions over banks and financial
institutions can be assigned to a quasi-autonomous
body sponsored by RBI.
• 3. A phased reduction in statutory liquidity ratio.
• 4. Phased achievement of 8% capital adequacy ratio.
• 5. Abolition of branch licensing policy.
 First Narasimhan Committee Report – 1991

• 6. Proper classification of assets and full disclosure of accounts of

banks and financial institutions.

• 7. Deregulation of Interest rates.

• 8. Delegation of direct lending activity of IDBI to a separate

corporate body.

• 9. Competition among financial institutions on participating

approach.

• 10. Setting up Asset Reconstruction fund to take over a portion of

the loan portfolio of banks whose recovery has become difficult.
 Banking Reform Measures of Government:
• On the recommendations of Narasimhan Committee, following measures
were undertaken by government since 1991: –
1. Lowering SLR and CRR-
• The high SLR and CRR reduced the profits of the banks. The SLR had been
reduced from 38.5% in 1991 to 18% in 2022. This has left more funds with
banks for allocation to agriculture, industry, trade etc.
• The Cash Reserve Ratio (CRR) is the cash ratio of banks total deposits to be
maintained with RBI. The CRR had been brought down from 15% in 1991 to
4% in 2022. The purpose is to release the funds locked up with RBI.
2. Prudential Norms –
• Prudential norms have been started by RBI in order to impart
professionalism in commercial banks. The purpose of prudential norms
includes proper disclosure of income, classification of assets and provision
for bad debts so as to ensure that the books of commercial banks reflect the
accurate and correct picture of financial position.
• Prudential norms required banks to make 100% provision for all Non-
performing Assets (NPAs). Funding for this purpose was placed at Rs. 10,000
crores phased over 2 years.
Banking Reform Measures of Government:

3. Capital Adequacy Norms (CAN): –

• Capital Adequacy ratio is the ratio of minimum capital to
risk asset ratio. In April 1992 RBI fixed CAN at 8%. By
March 1996, all public sector banks had attained the ratio
of 8%. It was also attained by foreign banks.
 Banking Reform Measures of Government:

4. Deregulation of Interest Rates

• The Narasimhan Committee advocated that interest rates should be allowed to

be determined by market forces. Since 1992, interest rates have become much
simpler and freer.
• Scheduled Commercial banks have now the freedom to set interest rates on their
deposits subject to minimum floor rates and maximum ceiling rates.
• The interest rate on domestic term deposits has been decontrolled.
• The prime lending rate of SBI and other banks on general advances of over Rs. 2
lakhs has been reduced.
• The rate of Interest on bank loans above Rs. 2 lakhs has been fully decontrolled.
• The interest rates on deposits and advances of all Co-operative banks have been
deregulated subject to a minimum lending rate of 13%.
5. Recovery of Debts
• The Government of India passed the “Recovery of debts due to Banks and
Financial Institutions Act 1993” in order to facilitate and speed up the recovery of
debts due to banks and financial institutions. Six Special Recovery Tribunals have
been set up. An Appellate Tribunal has also been set up in Mumbai.
Banking Reform Measures of Government:
6. Competition from New Private Sector Banks
• Banking is open to the private sector.
• New private sector banks have already started functioning.
These new private sector banks are allowed to raise capital
contribution from foreign institutional investors up to 20% and
from NRIs up to 40%. This has led to increased competition.
7. Access To Capital Market

• The Banking Companies (Acquisition and Transfer of

Undertakings) Act was amended to enable the banks to raise
capital through public issues. This is subject to the provision
that the holding of Central Government would not fall below
51% of paid-up-capital. SBI has already raised a substantial
amount of funds through equity and bonds.
Banking Reform Measures of Government:

8. Freedom of Operation
• Scheduled Commercial Banks are given freedom to open
new branches and upgrade extension counters, after
attaining capital adequacy ratio and prudential
accounting norms. The banks are also permitted to close
non-viable branches other than in rural areas.
9. Local Area Banks (LABs)
• In 1996, RBI issued guidelines for setting up of Local Area
Banks, and it gave Its approval for setting up of 7 LABs in
private sector. LABs will help in mobilizing rural savings
and in channeling them into investment in local areas.
Banking Reform Measures of Government:
• 10. Supervision of Commercial Banks
• The RBI has set up a Board of financial Supervision with
an advisory Council to strengthen the supervision of
banks and financial institutions. In 1993, RBI established a
new department known as Department of Supervision as
an independent unit for supervision of commercial banks.
 Narasimham Committee Report II – 1998
• In 1998 the government appointed yet another
committee under the chairmanship of Mr Narsimham.
• It is better known as the Banking Sector Committee. It
was told to review the banking reform progress and
design a programme for further strengthening the
financial system of India.
• The committee focused on various areas such as capital
adequacy, bank mergers, bank legislation, etc.
 Narasimham Committee Report II – 1998
• It submitted its report to the Government in April 1998 with the following
recommendations.
• Strengthening Banks in India : The committee considered the stronger
banking system in the context of the Current Account Convertibility ‘CAC’.
It thought that Indian banks must be capable of handling problems
regarding domestic liquidity and exchange rate management in the light of
CAC. Thus, it recommended the merger of strong banks which will have
‘multiplier effect’ on the industry.
• Narrow Banking : Those days many public sector banks were facing a
problem of the Non-performing assets (NPAs). Some of them had NPAs
were as high as 20 percent of their assets. Thus for successful
rehabilitation of these banks, it recommended ‘Narrow Banking Concept’
where weak banks will be allowed to place their funds only in the short
term and risk-free assets.
• Capital Adequacy Ratio : In order to improve the inherent strength of the
Indian banking system the committee recommended that the Government
should raise the prescribed capital adequacy norms. This will further
improve their absorption capacity also. Currently, the capital adequacy
ratio for Indian banks is at 9 percent.
Narasimham Committee Report II – 1998
• Bank ownership : As it had earlier mentioned the freedom for banks
in its working and bank autonomy, it felt that the government
control over the banks in the form of management and ownership
and bank autonomy does not go hand in hand and thus it
recommended a review of functions of boards and enabled them to
adopt professional corporate strategy.
• Review of banking laws : The committee considered that there was
an urgent need for reviewing and amending main laws governing
Indian Banking Industry like RBI Act, Banking Regulation Act, State
Bank of India Act, Bank Nationalization Act, etc.
• This up gradation will bring them in line with the present needs of
the banking sector in India.
• Apart from these major recommendations, the committee has also
recommended faster computerization, technology up gradation,
training of staff, depoliticizing of banks, professionalism in banking,
reviewing bank recruitment, etc.