Banking Sector Reforms

First Narasimhan Committee Report – 1991

To promote the healthy development of the financial sector, the Narasimhan committee made recommendations.

Recommendations of Narasimhan Committee

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.

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 25% in 1997. 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 4.1% in June 2003. 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.

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.

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.

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.

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 channelling them into investment in local areas.

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.

It submitted its report to the Government in April 1998 with the following recommendations.

1. 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.
2. 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.
3. 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.
4. 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.
5. 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 Nationalisation 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.

C.Nachiket Mor committee

The Committee on Comprehensive Financial Services for Small Businesses and Low-Income Households, set up by the RBI in September 2013, was mandated with the task of framing a clear and detailed vision for financial inclusion and financial deepening in India.

In its final report, the Committee has outlined six vision statements for full financial inclusion and financial deepening in India:

The Committee further lays down a set of four design principles namely;

1. Stability,
2. Transparency,
3. Neutrality, and
4. Responsibility,

• The principles will guide the development of institutional frameworks and regulation for achieving the visions outlined. Any approach that seeks to achieve the goals of financial inclusion and deepening must be evaluated based on its impact on overall systemic risk and stability, and at no cost should the stability of the system be compromised.
• A well-functioning financial system must also mandate participants to build completely transparent balance sheets that are made visible in a high-frequency manner, accurately reflecting both the current status and the impact of stressful situations on this status.
• In addition, the treatment of each participant in the financial system must be strictly neutral and entirely determined by the role it is expected to perform in the system and not its specific institutional character.
• Finally, the financial system must maintain the principle that the provider is responsible for sale of suitable financial services to customers and ensure that providers are incentivised to make every effort to offer customers only welfare-enhancing products and not offer those that are not.
• At its core the Committee’s recommendations argue that in order to achieve the vision of full financial inclusion and financial deepening in a manner that enhances systemic stability, there is a need to move away from a limited focus on anyone model to an approach where multiple models and partnerships are allowed to emerge, particularly between national full-service banks, regional banks of various types, non-bank finance companies, and financial markets. Thus, the recommendations of the Committee seek to encourage partnerships between specialists, instead of focussing only on the large generalist institutions.
• In the spirit of the RBI’s approach paper on differentiated Banks, the Committee recommends that the RBI may also seriously consider licensing, with lowered entry barriers but otherwise equivalent treatment, more functionally focused banks like Payments Banks, Wholesale Consumer Banks, and Wholesale Investment Banks.
• Payments Banks are envisaged as entities that would focus on ensuring rapid out-reach with respect to payments and deposit services.
• The Wholesale Consumer Banks and Wholesale Investment Banks would not take retail deposits but would instead focus their attention on expanding the penetration of credit services.
• The Committee also recommends that the extant Priority Sector Lending norms be modified in order to allow and incentivize providers to specialise in one or more sectors of the economy and regions of the country, rather than requiring each and every bank to enter all the segments.
• Finally, the Committee proposes a shift in the current approach to customer protection to one that places a greater onus on the financial services provider to provide suitable products and services.
• The committee has suggested a fixed term of 5 years for the chairman/managing director of a bank and a term of 3 years for a whole-time director.

PJ Nayak Committee

Key Observations

Specific Recommendations made by the committee.

By
Himanshu Arora
Doctoral Scholar in Economics & Senior Research Fellow, CDS, Jawaharlal Nehru University