The current CRR Rate 2016 – 4% and SLR – 21.

25%

Banking Sector Reforms

During the decades of 1960 and 1970’s India nationalized most of its banks. This made India to
borrow loan money from International Monetary Fund (IMF) to meet its financial obligations.
This event called the question on baking policies of India and influenced the reforms in banking
sector due to conditions for loan laid down by IMF and world bank.

In light of these requirements two expert committee were set up in 1990’s.

1. Under the chairmanship of Narasimhan (Ex. RBI Governor) - Narasimhan Committee on

Financial Sector Reforms -1991
2. The Second Committee was appointed by P. Chidhambaram as Finance Minister -
Narasimhan Committee on Banking Sector Reforms -1998

Narasimhan Committee Report -1991

The Narasimhan Committee was set up in order to study the problems of Indian Financial
System and to suggest some recommendations for improvement in the efficiency and
productivity of financial institution.

The committee has given the following major recommendations:

1. Reduction in SLR and CRR: The committee recommended the reduction of the higher
proportion of the SLR and CRR. Both of these ratios were high at that time. The high amount
of SLR and CRR locked the bank resources and bank had very less amount to lend to public.
The reduction of CRR and SLR will lead to high amount of money with the bank for disposal
of loans.
2. Phasing out direct credit programme: In India, credit allocation was under government.
The committee said bank should take this position. The priority sector should be redefined.
This programs compelled banks to set aside their resources for the needy and poor sector at
concessional rate of interest.
3. Interest rate reduction: Previously, the interest rate in India were regulated and controlled
by the authorities. The committee recommended deregulation of Interest rates to reflect
emerging market conditions. The government control on interest rate was eliminated. So, that
Interest rates vary based on changes in demand and supply of money.

4. Structural Reorganization of banking sector: The committee recommended that actual

number of public sector banks need to be reduced. The large banks with international
character, 8- 10 national banks with branches throughout the country, local banks confined to
specific region of the country, rural banks confined to rural areas.

5. Better transparency of Banking Sector: Income recognition, asset classification and

provisioning norms have been introduced for the banking industry. The norms are more
prudent, objective, transparent, uniform and designed to avoid subjectivity. Greater emphasis
is laid on internal audit and internal inspection in the banks.

6. Establishment of Asset Reconstruction Fund (ARF) Tribunal: The NPA rates were very
high those days so the committee recommended setting up of Assets Reconstruction Fund
(ARF). This would take over from banks and financial institutions a portion of their bad and
doubtful debts at a discount (based on realisable value of assets). The tribunal would also
help bank to subsequently follow up on the recovery of the dues owed to them from the
primary borrowers.

7. Removal of Dual control over Banking System: The banks were under the dual control of
RBI and Banking Division of Ministry of Finance before 1991. The committee recommended
RBI Should be the only main agency to regulate banking in India.

8. Control Bank Expansion and Nationalization: Government should indicate that there

would be no further nationalisation of banks, the new banks in the private sector should be

permitted subject to normal requirements of the RBI, branch licensing should be abolished
and policy towards foreign banks should be more liberal.
 Narasimham Committee on Banking Sector Reforms - 1998

In early 1997, Mr.Narasimham was again asked to chair another committee to review the progress
based on the 1st Committee report and to suggest a new vision for Indian banking industry. In April,
1998, Narasimham Committee submitted its report and recommended some major changes in the
financial sector. Many of these recommendations have been accepted and are under process of
implementation.

These recommendations can be broadly classified into following categories:-

(A) Strengthening Banking System

(B) Asset Quality

(C) Prudential Norms and Disclosure Requirements

(D) Systems and Methods in Banks

(E) Structural Issues

(A) Strengthening Banking System

 Capital adequacy requirements should take into account market risks in addition to the credit risks
 Government and other approved securities which are now subject to a zero risk weight, should have
a 5 per cent weight for market risk.
 Foreign exchange open credit limit risks should be integrated into the calculation of risk weighted
assets.
 Minimum capital to risk assets ratio (CRAR) be increased from the existing 8 per cent to 10 per cent.
Individual banks' shortfalls in the CRAR be treated on the same line as adopted for CRR and SLR
requirements, viz. uniformity across weak and strong banks. There should be penal (fine) provisions
for banks that do not maintain CRAR.
 Public Sector Banks in a position to access the capital market at home or abroad be encouraged, as
subscription to bank capital funds cannot be regarded as a priority claim on budgetary resources.

(B) Asset Quality

 An asset be classified as standard assets, sub - standard assets, doubtful assets, doubtful assets.
 For evaluating the quality of assets portfolio, advances covered by Government guarantees, which
may not be returned, be treated as NPAs. Exclusion of such advances should be separately shown to
facilitate fuller disclosure and greater transparency of operations
 The interest subsidy element in credit for the priority sector should be totally eliminated and
interest rate on loans under Rs.2 lakhs should be deregulated for scheduled commercial banks as
has been done in the case of Regional Rural Banks and cooperative credit institutions

(C ) Prudential Norms and Disclosure Requirements

 In India, income stops occur when interest or installment of principal is not paid within 180 days,
which should be reduced to 90 days in a phased manner by 2002.
 Introduction of a general provision of 1 per cent on standard assets in a phased manner be
considered by RBI.
 As an incentive to make specific provisions, they may be made tax deductible

(D) Systems and Methods in Banks

 There should be an independent loan review mechanism especially for large borrowal accounts and
systems to identify potential NPAs.
 Banks may evolve a filtering mechanism by stipulating in-house prudential credit limits based on
credit rating of the customer. The major banks have already implemented these exposure limits.
Slowly other banks are also progressing in this field.
 Banks and Financial Institutions should have a system of recruiting skilled manpower by conducting
exams, they should not depend on referrals.
 Public sector banks should be given flexibility to determine managerial remuneration levels taking
into account market trends.
 There may be need to redefine the scope of external vigilance and investigation agencies with
regard to banking business.
 There is need to develop information and control system in several areas like better tracking of
spreads, costs and NPSs for higher profitability, accurate and timely information for strategic
decision to identify and promote profitable products and customers, risk and asset-liability
management; and efficient treasury management.
 Risk Management, Asset Liability Management and improvement in treasury have already been
introduced in banks.

(E) Structural Issues

A Development Financial Institution which converts to bank be given time to face in reserve equipment
in respect of its liability to bring it on par with requirement relating to commercial bank. The process has
already started. ICICI Ltd. Has converted itself into a bank by merger with ICICI Bank Ltd. IDBI, SIDBI too
have followed the same.

Mergers of Public Sector Banks should emanate from the management of the banks with the
Government as the common shareholder playing a supportive role. Merger should not be seen as a
means of bailing out weak banks. Mergers between strong banks/FIs would make for greater economic
and commercial sense.

Indian Banks have yet to take cue from this recommendation and are apprehensive of the mergers.

‘Weak Banks' may be nurtured into healthy units by slowing down on expansion, eschewing high cost
funds / borrowings etc.

Government is already taking steps in this direction

The minimum share of holding by Government/Reserve Bank in the equity of the nationalised banks
and the State Bank should be brought down to 33%. The RBI regulator of the monetary system should
not be also the owner of a bank in view of the potential for possible conflict of interest

These are yet to be implemented

There is a need for a reform of the deposit insurance scheme based on CAMELs ratings awarded by RBI
to banks.

Inter-bank call and notice money market and inter-bank term money market should be strictly restricted
to banks; only exception to be made is primary dealers.

RBI has already taken number of seps in this direction.

Non-bank parties be provided free access to bill rediscounts, CPs, CDs, Treasury Bills, MMMF.

RBI should totally withdraw from the primary market in 91 days Treasury Bills.

Major Recommendations by the 2nd Narasimham Committee on Banking Sector

Reforms

In early 1997, Mr.Narasimham was again asked to chair another committee to review the progress based on the
1st Committee report and to suggest a new vision for Indian banking industry. In April, 1998, Narasimham Committee
submitted its report and recommended some major changes in the financial sector. Many of these recommendations have
been accepted and are under process of implementation.
These recommendations can be broadly classified into following categories :-
(A) Strengthening Banking System
 (B) Asset Quality
(C) Prudential Norms and Disclosure Requirements
(D) Systems and Methods in Banks
(E) Structural Issues

(A) Strengthening Banking System

RECOMMEDNATION PRESENT STATUS
Capital adequacy requirements should take into account market RBI has already implemented the same as market
risks in addition to the credit risks risks already taken into account for investment
portfolio.
In the next three years the entire portfolio of government More stringent norms under Basel II already
securities should be marked to market and the schedule for the implemented.
same announced at the earliest (since announced in the
monetary and credit policy for the first half of 1998-99);
government and other approved securities which are now
subject to a zero risk weight, should have a 5 per cent weight
for market risk.

Risk weight on a government guaranteed advance should be the This has already been implemented by RBI.
same as for other advances. This should be made prospective
from the time the new prescription is put in place.

Foreign exchange open credit limit risks should be integrated More stringent norms under Basel II already
into the calculation of risk weighted assets and should carry a implemented.
100 per cent risk weight

Minimum capital to risk assets ratio (CRAR) be increased from More stringent norms under Basel II already
the existing 8 per cent to 10 per cent; an intermediate minimum implemented.
target of 9 per cent be achieved by 2000 and the ratio of 10 per
cent by 2002; RBI to be empowered to raise this further for
individual banks if the risk profile warrants such an increase.
Individual banks' shortfalls in the CRAR be treated on the same
line as adopted for reserve requirements, viz. uniformity across
weak and strong banks. There should be penal provisions for
banks that do not maintain CRAR.
Public Sector Banks in a position to access the capital market at Public sector banks are already accessing the
home or abroad be encouraged, as subscription to bank capital capital market, e.g. PNB, Canara Bank, UCO
funds cannot be regarded as a priority claim on budgetary Bank, Union Bank etc. have already successfully
resources. launched IPOs.

(B) Asset Quality

NPA norms have been implemented

An asset be classified as doubtful if it is in the
substandard category for 18 months in the first
instance and eventually for 12 months and loss if it
has been identified but not written off. These norms
should be regarded as the minimum and brought
into force in a phased manner

For evaluating the quality of assets portfolio, These are yet to be implemented.
advances covered by Government guarantees,
which have turned sticky, be treated as NPAs.
Exclusion of such advances should be separately
shown to facilitate fuller disclosure and greater
transparency of operations

For banks with a high NPA portfolio, two First Asset Reconstruction Company was
alternative approaches could be adopted. One established during June, 2002.
approach can be that, all loan assets in the doubtful
and loss categories, should be identified and their
realisable value determined. These assets could be
transferred to an Assets Reconstruction Company
(ARC) which would issue NPA Swap Bonds
An alternative approach could be to enable the Tier II bonds are being issued by the Banks, but
banks in difficulty to issue bonds which could form these are not eligible for SLR investments by
part of Tier II capital, backed by government banks.
guarantee to make these instruments eligible for
SLR investment by banks and approved
instruments by LIC, GIC and Provident Funds
The interest subsidy element in credit for the
priority sector should be totally eliminated and
interest rate on loans under Rs.2 lakhs should be
deregulated for scheduled commercial banks as has
been done in the case of Regional Rural Banks and
cooperative credit institutions

(C ) Prudential Norms and Disclosure Requirements

In India, income stops accruing when interest or Implemented w.e.f. year ending 31/03/2004.
installment of principal is not paid within 180 days,
which should be reduced to 90 days in a phased
manner by 2002.
Introduction of a general provision of 1 per cent on Already implemented
standard assets in a phased manner be considered
by RBI.

As an incentive to make specific provisions, they

may be made tax deductible

(D) Systems and Methods in Banks

There should be an independent loan review The major banks have already implemented
mechanism especially for large borrowal accounts these exposure limits. Slowly other banks are
and systems to identify potential NPAs. Banks may also progressing in this field.
evolve a filtering mechanism by stipulating in-
house prudential limits beyond which exposures on
single/group borrowers are taken keeping in view
their risk profile as revealed through credit rating
and other relevant factors

Banks and FIs should have a system of recruiting Banks are already recruiting specialist officers
skilled manpower from the open market from the open market.
Public sector banks should be given flexibility to This is partially being implented
determined managerial remuneration levels taking
into account market trends.

There may be need to redefine the scope of external

vigilance and investigation agencies with regard to
banking business.
There is need to develop information and control Risk Management, Asset Liability Management
system in several areas like better tracking of and improvement in treasury have already been
spreads, costs and NPSs for higher profitability, introduced in banks.
accurate and timely information for strategic
decision to identify and promote profitable products
and customers, risk and asset-liability management;
and efficient treasury management.

(E) Structural Issues

With the conversion of activities between banks The process has already started. ICICI Ltd. Has
and DFIs, the DFIs should, over a period of time converted itself into a bank by merger with
convert themselves to bank. A DFI which converts ICICI Bank Ltd. IDBI, SIDBI too have
to bank be given time to face in reserve equipment followed the same.
in respect of its liability to bring it on par with
requirement relating to commercial bank.

Mergers of Public Sector Banks should emanate Indian Banks have yet to take cue from this
from the management of the banks with the recommendation and are apprehensive of the
Government as the common shareholder playing a mergers.
supportive role. Merger should not be seen as a
means of bailing out weak banks. Mergers between
strong banks/FIs would make for greater economic
and commercial sense.

‘Weak Banks' may be nurtured into healthy units by Government is already taking steps in this
slowing down on expansion, eschewing high cost direction
funds / borrowings etc.
The minimum share of holding by These are yet to be implemented
Government/Reserve Bank in the equity of the
nationalised banks and the State Bank should be
brought down to 33%. The RBI regulator of the
monetary system should not be also the owner of a
bank in view of the potential for possible conflict of
interest
There is a need for a reform of the deposit
insurance scheme based on CAMELs ratings
awarded by RBI to banks.
Inter-bank call and notice money market and inter- RBI has already taken number of seps in
bank term money market should be strictly this direction.
restricted to banks; only exception to be made is
primary dealers.
Non-bank parties be provided free access to bill
rediscounts, CPs, CDs, Treasury Bills, MMMF.

RBI should totally withdraw from the primary

market in 91 days Treasury Bills.