Banking Sector Reforms in India After 1991

BANKING SECTOR REFORMS POST LIBERALIZATION PERIOD

Since nationalisation of banks in 1969, the banking sector had been dominated by the public sector. There was financial repression, role of technology was limited, no risk management etc. This resulted in low profitability and poor asset quality. The country was caught in deep economic crises. The Government decided to introduce comprehensive economic reforms. Banking sector reforms were part of this package. In august 1991, the Government appointed a committee on financial system under the chairmanship of M. Narasimhan.

FIRST PHASE OF BANKING SECTOR REFORMS / NARASIMHAN COMMITTEE REPORT – 1991: To promote healthy development of financial sector, the Narasimhan committee made recommendations.

I) RECOMMENDATIONS OF NARASIMHAN COMMITTEE:

1.    Establishment of 4 tier hierarchy for banking structure with 3 to 4 large banks (including SBI) at 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.    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 loan portfolio of banks whose recovery has become difficult.

II) 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 has 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 a bank’s total deposits to be maintained with RBI. The CRR has 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 include 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 rate has become much simpler and freer.

a)    Scheduled Commercial banks have now the freedom to set interest rates on their deposits subject to minimum floor rates and maximum ceiling rates.

b)    Interest rate on domestic term deposits has been decontrolled.

c)    The prime lending rate of SBI and other banks on general advances of over Rs. 2 lakhs has been reduced.

d)    Rate of Interest on bank loans above Rs. 2 lakhs has been fully decontrolled.

e)    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: Now banking is open to 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.    Phasing Out Of Directed Credit: The committee suggested phasing out of the directed credit programme. It suggested that credit target for priority sector should be reduced to 10% from 40%. It would not be easy for government as farmers, small industrialists and transporters have powerful lobbies.

8.    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 provision that the holding of Central Government would not fall below 51% of paid-up-capital. SBI has already raised substantial amount of funds through equity and bonds.

9.    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.

10.  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 in to investment in local areas.

11.  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.