In 1991, the country was caught into a deep crisis. The government at this juncture decided to introduce comprehensive economic reforms. The banking sector reforms were part of this package. The main objective of Indian banking sector reforms was to promote a diversified, efficient and competitive financial system with the ultimate goal of improving the allocative efficiency of resources through operational flexibility, improved financial viability and institutional strengthening. Many of the regulatory and supervisory norms were initiated first for the commercial banks and were later extended to other types of financial intermediaries. While nudging the Indian banking system to better health through the introduction of international best practices in prudential regulation and supervision early in the reform process, the main idea was to increase competition in the system gradually. The reforms have focused on removing financial repression through reductions in statutory preemptions, while stepping up prudential regulations at the same time. Furthermore, interest rates on both deposits and lending of banks had been progressively deregulated.
In August 1991, the Government appointed a committee under the chairmanship of M. Narasimham, which worked for the liberalization of banking practices. The aim of this Committee was to bring about ‘operational flexibility’ and ‘functional autonomy’ so as to enhance efficiency, productivity and profitability of banks.
The Committee submitted its report in November, 1991 and recommended;
- ‘Reduction in CRR to 8.5 percent and SLR to 25 percent over a period of about five years.
- Deregulation of interest rates structure and decreasing the emphasis laid on directed credit and phasing out the concessional rates of interest to priority sector.
- To raise fresh capital through public issue by the profit making banks.
- Transparency in Balance sheets
- Establishment of Special Tribunals to speed up the process of debts recovery
- Establishment of an Assets Reconstruction Fund with special power of recovery
- Bank restructuring through evolving a system of a broad pattern consisting of 3 or 4 large banks including SBI, 8-10 national Banks engaged in ‘Universal’ Banking with a network of branches, local banks confined to a specific region and RRBs confined to the rural areas engaged in financing of agriculture and allied activities.
- Abolishment of branch licensing and leaving the matter of opening and closing of branches to the commercial judgment of individual banks
- Progressive reduction in pre-emptive reserves.
- Introduction of prudential norms to ensure capital adequacy norms, proper income recognition, more stringent recognition of NPAs, classification of assets based on their quality and provisioning against bad and doubtful debts by constituting the special debt recovery tribunals
- Introduction of greater competition by entry of private sector banks and foreign banks and permitting them to access capital market
- Partial deviation from directed lending
- Strengthening the supervisory mechanism by creating a separate Board for Banking and Financial supervision
- Up gradation of technology through the introduction of computerized system in banks.
- Freedom to appoint chief executive and officers of the banks and changes in the constitutions of the board
- Bringing NBFC’S under the ambit of regulatory framework.
The Government also appointed another committee on banking sector reforms under the Chairmanship of M. Narasimham which submitted its report in April 1998. The committee focused on bringing about structural changes so as to strengthen the foundations of the banking system to make it more stable. The major recommendations of Narasimham Committee II were,
- ‘In case of capital adequacy, strengthening the banking system through an increase in the minimum capital adequacy ratio (CAR) from 8 percent to 10 percent by 2002, 100 percent of fixed income portfolio marked-to-market by 2001 (up from 70 percent), 5 percent market risk weight for fixed income securities and open foreign exchange positions limits (no market risks weights previously) and 100 percent commercial risks weight to Government-Guaranteed advances (previously treated as risk free)
- To bring down net NPAs below 5 percent by 2000 and to 3 percent by 2002.
Reducing the minimum stipulated holding of the Government or RBI in the equity of nationalized banks or SBI to 33 percent
- Merging financially strong institutions and giving a revival package to the weak banks
- Strengthening the operation of rural financial institutions in terms of appraisal, supervision and follow-up, loan recovery strategies and development of bank-client relationships in view of higher NPAs in public sector banks due to directed lending.
- Amendment to RBI Act and Banking Regulation Act 4
The Government focused on competition enhancing measures by way of granting operational autonomy to public sector banks, reduction of public ownership in public sector banks by allowing them to raise capital from equity market up to 49 percent of paid-up capital; setting of transparent norms for entry of Indian private sector, foreign and joint-venture banks and insurance companies, giving permission for foreign investment in the financial sector in the form of foreign direct investment (FDI) as well as portfolio investment, giving permission to banks to diversify product portfolio and business activities, to prepare a roadmap for presence of foreign banks and guidelines for mergers and amalgamation of private sector banks, public sector banks and NBFCs, and providing guidelines on ownership and governance in private sector banks.
Government focused through reform process on enhancing the role of market forces by making sharp reduction in pre-emption through reserve requirement, market determined pricing for government securities, disbanding of administered interest rates with a few exceptions and enhanced transparency and disclosure norms to facilitate market discipline; introduction of pure inter-bank call money market, auction-based repos reverse repos for short-term liquidity management, facilitation of improved payments and settlement mechanism, and requirement of significant advancement in dematerialization and markets for securitized assets are being developed.
A provision was made for introduction and phased implementation of international best practices and norms on risk-weighted capital adequacy requirement, accounting, income recognition, provisioning and exposure, taking suitable measures to strengthen risk management through recognition of different components of risk, assignment of risk-weights to various asset classes, norms on connected lending, risk concentration, application of marked-to-market principle for investment portfolio and limits on deployment of fund in sensitive activities, and ‘Know Your Customer‘ and ‘Anti Money Laundering‘ guidelines, roadmap for Basel II, introduction of capital charge for market risk, higher graded.