banking reforms and report
TRANSCRIPT
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BANKING REFORMS AND REPORTS
INTRODUCTION:
The changes in Indian banking since liberalization have been no less marked than those in the
financial markets. In relatively less conspicuous but equally certain ways, the banking sector has
moved towards greater privatization and globalization in the decade and a half since
liberalization. As in the case of financial markets, the ride has not been free of bumps, but on the
whole, it has stayed on course. Larger private banks often floated by public institutions as
well as foreign banks have entered the arena and several new financial products are being
offered. While mishaps like the Global Trust Bank collapse have occasionally shaken the
confidence of depositors and the financial system, timely intervention and bail-out, regardless of
their feared long-term effects, have avoided them from boiling over to crisis proportions.
As the real sector reforms began in 1992, the need was felt to restructure the
Indian banking industry. The reform measures necessitated the deregulation of the financial
sector, particularly the banking sector. The initiation of the financial sector reforms brought
about a paradigm shift in the banking industry. In 1991, the RBI had proposed to form the
committee chaired by M. Narasimham, former RBI Governor in order to review the Financial
System viz. aspects relating to the Structure, Organisations and Functioning of the financial
system. The Narasimham Committee report, submitted to the then finance minister, Manmohan
Singh, on the banking sector reforms highlighted the weaknesses in the Indian banking system
and suggested reform measures based on the Basle norms. The guidelines that were issued
subsequently laid the foundation for the reformation of Indian banking sector.
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GOIPORIA COMMITTEE
For over two decades, the Government, the Reserve Bank of India and the banks have been
seriously concerned about the Customer Service in banks. Several studies were instituted and
strategies evolved to improve the Customer Service. As early as in 1972, the Banking
Commission, appointed by the Government of India under the Chairmanship of Veteran Co-
operative banker Sri R. G. Saraiya, had made several recommendations on Customer Service.
Later, in the year 1975 the Government appointed a Working Group on Customer Service in
banks under the Chairmanship of Sri R.K. Talwar. This Working Group made 176
recommendations covering all the important areas relating to customer service besides some
general recommendations. For monitoring the implementation of these recommendations, a
Standing Committee on Customer Service of Banks with representatives from Ministry of
Finance, RBI and the IBA and a few public sector banks was constituted.
In the decade of 80s, greater importance was given for the redressal of grievances of customers.
The Government and the RBI, to redress the grievances took several steps such as setting up of
Customer Service Committees, Customer Service Centres in various cities, Directorate of Public
Grievances under the Cabinet Secretariat etc., as also in the observance of Customer Day. The
year 1986 was celebrated by Public Sector Banks as Customer Service Year. The year 1988
witnessed further improvement in customer service with the implementation of the
recommendations of the Estimates Committee.
In response to the former Finance Ministers observation that the banking industry has to be
made more responsive to the needs to the public, the RBI constituted a Committee under the
Chairmanship of Mr. M.N. Goiporia in 1990, to look into the various aspects of customer
service.
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The Terms Of Reference Of The Said Committee Were:
1. The causes for the persistence of below par customer service in banks.
2. The areas in which deficiencies in customer service are prevalent and how these can be
remedied;
3. Improvement in work culture and inculcation of greater customer orientation on the part of the
bank Employees;
4. Identification of structural and operational rigidities and inadequacies in the existing systems
and procedures which adversely affect the working of banks, especially customer service, and
suggesting remedial measures with a view to ensuring greater flexibility and speedier transaction
of business;
5. Up-gradation of technology to ensure prompt and efficient service to customers, better
housekeeping, quicker flow of information and effective supervision and managerial control and
competitive strength.
For examining the level of customer service prevailing in banks and for framing its
recommendations for improvement, the Committee made use of several sources of information
including findings of the survey/studies conducted by the RBI and other organizations, direct
interaction with representatives of different consumer groups, discussions with Chairman and
executives of banks, visits to a few branches of banks and responses received to the
questionnaires circulated to the different customer interest groups.
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Increases customers choice of alternatives and more so in the service industry as the
measurement of service, which is intangible, is subjective and varies from time to time and from
person to person. However, to have the winning edge in a competitive market, the provision of
superior quality of service rendered would make all the difference. Total Quality Management
would, therefore, become an integral part for the organization in providing services.
Banking in the coming days as foreseen would be different with acute competition not only
amongst the banks themselves but also from other financial intermediaries. This would bring to
the fore, the two main factors viz., efficacy and customer service based on which the success rate
will be determined. Efficacy to a greater extent can be brought about by adopting the modern
infrastructural facilities and mechanization. Since customer service needs continuous up-
gradation, banks should constantly revive the level of service rendered and improve upon them
with the ultimate aim of satisfying the customer. In the years ahead, technology driven banking
alone can help in improving customer service. ATMs, net banking, phone-banking etc. will be
gaining importance in the days ahead and hence banks should give more attention to technology
and expansion of internet banking, ATM network etc. in the days to come.
The factoring services1 made an entry into India with deliberate attempt supported by theindustrial organizations and academicians as a step forward to upgrade economy in the year
1991. To introduce these services, for the first time, Working group on Money Market
popularly known as Vaghul Committee was constituted in 1987 which strongly recommended
for introducing factoring services, particularly for small scale units
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VAGHUL COMMITTEE:
Until few years ago, the Indian money market was small with transactions generally confined to
overnight borrowing and lending money by Bank/ financial institutions. Except commercial bills,
there was no major other short term negotiable instruments for dealing. The fixed interest rate
regime along with restrictions on entry of participants in the market provided little incentive for
market development, which was almost dormant. The money management was, therefore,
regarded as if no consequence by the investors, aspiring for better returns on short term funds.
The reserve Bank of India however, in due course of time, recognized the need for an active
secondary money market in India especially in the context of the setting up subsidiaries by many
banks for operating mutual fund schemes and ever expanding business of the unit Trust of India,
Life Insurance Corporation of India, Industrial Development bank of India and other financial
institutions which needed avenues for the development of funds flowing in regularly. For an in
depth study and to make recommendations on the step required to be taken for the development
of a healthy and active money market, the Reserve Bank of India, appointed a working group
under the Chairmanship of Shri. N. Vaghul in September 1986. The Bank of India for thedevelopment of the Indian money market. The broad objectives and the strategy laid down by the
Vaghul group serves as the milestone in the development of Indian money market. The working
group recommended that the money market should be made broad- based by introducing new
negotiable instruments and allowing more participants. Turnover or volume of trading is a sure
indicator of the growth and for increase in turnover, there has to be a free play of market forces
in fixing the rates and prices. The working group therefore recommended that the administered
interest rate regime should be given up initially in such financial transactions as are out through
the money market.
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The Specific Terms Of Reference Of The Vaghul Group Were:
To examine money market instruments and recommend specific measures for their development;
To recommend the pattern of money market interest rate and to indicate whether these should be
administered or determined by the market;
To study the feasibility of increasing the participants in the money market;
To assess the impact of changes in the cash credit system on the money market and to examine
the need for developing specialized institutions such as discount houses; and
To consider any issue having a bearing on the development of the money market.
Recommendations of the Committee:
The Vaghul Group, as a background to its recommendations, outlines the conceptual framework
in the form of broad objectives of the money market which are:
1. It should provide as equilibrium mechanism for evening out short term surpluses and
deficits;
2. It should provide a focal point for central bank intervention for influencing liquidity in
the economy;
3. It should provide reasonable access to users of short term money to meet their
requirements at a realistic price.
To achieve these objectives, the Vaghul group adopts a four pronged strategy:
a. Selective increase in the number of participants to broaden the base of the money market.
b. Activating the existing instruments and developing new ones so as to have a diversified
mix of instruments,
c. Orderly movement away from administered interest rates to market determined interest
rates and
d. Creation of an active secondary market through establishing new instruments
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NARSHIMAM COMMITTEE
During the decades of the 60s and the 70s, India nationalized most of its banks. This culminated
with the balance of payments crisis of the Indian economy where India had to airlift gold to
International Monetary Fund (IMF) to loan money to meet its financial obligations. This event
called into question the previous banking policies of India and triggered the era of economic
liberalization in India in 1991. Given that rigidities and weaknesses had made serious inroads
into the Indian banking system by the late 1980s, the Government of India (GOI), post-crisis,
took several steps to remodel the country's financial system. (Some claim that these reforms were
influenced by the IMF and the World Bankas part of their loan conditionality to India in 1991).
The banking sector, handling 80% of the flow of money in the economy, needed serious reforms
to make it internationally reputable, accelerate the pace of reforms and develop it into a
constructive usher of an efficient, vibrant and competitive economy by adequately supporting the
country's financial needs. In the light of these requirements, two expert Committees were set up
in 1990s under the chairmanship of M. Narasimham (an ex-RBI (Reserve Bank of India)
governor) which are widely credited for spearheading the financial sector reform in India. The
first Narasimhan Committee (Committee on the Financial System - CFS) was appointed by
Manmohan Singh as India's Finance Minister on 14 August 1991, and the second one
(Committee on Banking SectorReforms) was appointed by P.Chidambaram as Finance Minister
in December 1997. Subsequently, the first one widely came to be known as the Narasimham
Committee-I (1991) and the second one as Narasimham-II Committee (1998). This article is
about the recommendations of the Second Narasimham Committee, the Committee on Banking
Sector Reforms.
The purpose of the Narasimham-I Committee was to study all aspects relating to the structure,
organization, functions and procedures of the financial systems and to recommend improvements
in their efficiency and productivity. The Committee submitted its report to the Finance Ministerin November 1991 which was tabled in Parliament on 17 December 1991.
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The Narasimham-II Committee was tasked with the progress review of the implementation of the
banking reforms since 1992 with the aim of further strengthening the financial institutions of
India. It focused on issues like size of banks and capital adequacy ratio among other things. M.
Narasimham, Chairman, submitted the report of the Committee on Banking Sector Reforms
(Committee-II) to the Finance MinisterYashwant Sinha in April 1998.
Recommendations of the Committee:
The 1998 report of the Committee to the GOI made the following major recommendations:
Autonomy in Banking
Greater autonomy was proposed for the public sectorbanks in order for them to function with
equivalent professionalism as their international counterparts. For this the panel recommended
that recruitment procedures, training and remuneration policies of public sector banks be brought
in line with the best-market-practices of professional bank management. Secondly, the
committee recommended GOI equity in nationalized banks be reduced to 33% for increased
autonomy. It also recommended the RBI relinquish its seats on the board of directors of these
banks. The committee further added that given that the government nominees to theboard of
banks are often members of parliament, politicians, bureaucrats, etc., they often interfere in the
day-to-day operations of the bank in the form of the behest-lending. As such the committee
recommended a review of functions of banks boards with a view to make them responsible for
enhancing shareholder value through formulation of corporate strategy and reduction of
government equity.
To implement this, criteria for autonomous status was identified by March 1999 (among other
implementation measures) and 17 banks were considered eligible for autonomy. But some
recommendations like reduction in Government's equity to 33%, the issue of greater
professionalism and independence of the board of directors of public sector banks is still
awaiting Government follow-through and implementation.
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Reform in the Role of RBI
First, the committee recommended that the RBI withdraw from the 91-day treasury bills market
and that interbank call money and term money markets be restricted to banks and primary
dealers. Second, the Committee proposed a segregation of the roles of RBI as a regulator of
banks and owner of bank. It observed that "The Reserve Bank as a regulator of the monetary
system should not be the owner of a bank in view of a possible conflict of interest". As such, it
highlighted that RBI's role of effective supervision was not adequate and wanted it to divest its
holdings in banks and financial institutions.
Pursuant to the recommendations, the RBI introduced a Liquidity Adjustment Facility (LAF)
operated through repo and reverse repos in order to set a corridor for money market interest
rates. To begin with, in April 1999, an Interim Liquidity Adjustment Facility (ILAF) was
introduced pending further up gradation in technology and legal/procedural changes to facilitate
electronic transfer.[18] As for the second recommendation, the RBI decided to transfer its
respective shareholdings of public banks like State Bank of India (SBI), National Housing Bank
(NHB) and National Bank for Agriculture and Rural Development (NABARD) to GOI.
Subsequently, in 2007-08, GOI decided to acquire entire stake of RBI in SBI, NHB and
NABARD. Of these, the terms of sale for SBI were finalized in 2007-08 itself.
Stronger Banking System
The Committee recommended for merger of large Indian banks to make them strong enough for
supporting international trade. It recommended a three tier banking structure in India through
establishment of three large banks with international presence, eight to ten national banks and a
large number of regional and local banks. This proposal had been severely criticized by the RBI
employees union. The Committee recommended the use of mergers to build the size and strength
of operations for each bank. However, it cautioned that large banks should merge only with
banks of equivalent size and not with weaker banks, which should be closed down if unable to
revitalize themselves.[6]Given the large percentage ofnon-performing assets for weaker banks,
some as high as 20% of their total assets, the concept of "narrow banking" was proposed to assist
in their rehabilitation.[11]
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Non-Performing Assets
Non-performing assets had been the single largest cause of irritation of the banking sector of
India. Earlier the Narasimham Committee-I had broadly concluded that the main reason for the
reduced profitability of the commercial banks in India was the priority sector lending. The
committee had highlighted that 'priority sector lending' was leading to the buildup of non-
performing assets of the banks and thus it recommended it to be phased out. Subsequently, the
Narasimham Committee-II also highlighted the need for 'zero' non-performing assets for all
Indian banks with International presence. The 1998 report further blamed poor credit decisions,
behest-lending and cyclical economic factors among other reasons for the buildup of the non-
performing assets of these banks to uncomfortably high levels. The Committee recommended
creation of Asset Reconstruction Funds or Asset Reconstruction Companies to take over the baddebts of banks, allowing them to start on a clean-slate. The option of recapitalization through
budgetary provisions was ruled out. Overall the committee wanted a proper system to identify
and classify NPAs,NPAs to be brought down to 3% by 2002[4] and for an independent loan
review mechanism for improved management of loan portfolios. The committee's
recommendations let to introduction of a new legislation which was subsequently implemented
as the Securitization and Reconstruction of Financial Assets and Enforcement of Security
Interest Act, 2002 and came into force with effect from 21 June 2002.
Capital Adequacy and Tightening Of Provisioning Norms
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
would also improve their risk taking ability. The committee targeted raising the capital adequacy
ratio to 9% by 2000 and 10% by 2002 and have penal provisions for banks that fail to meet these
requirements. For asset classification, the Committee recommended a mandatory 1% in case of
standard assets and for the accrual of interest income to be done every 90 days instead of 180
days.
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To implement these recommendations, the RBI in Oct 1998, initiated the second phase of
financial sector reforms by raising the banks' capital adequacy ratio by 1% and tightening the
prudential norms for provisioning and asset classification in a phased manner on the lines of the
Narasimham Committee-II report. The RBI targeted to bring the capital adequacy ratio to 9% by
March 2001. The mid-term Review of the Monetary and Credit Policy of RBI announced another
series of reforms, in line with the recommendations with the Committee, in October 1999.
Entry of Foreign Banks
The committee suggested that the foreign banks seeking to set up business in India should have a
minimum start-up capital of $25 million as against the existing requirement of $10 million. It
said that foreign banks can be allowed to set up subsidiaries and joint ventures that should be
treated on a par with private banks.
Initially, the recommendations were well received in all quarters, including the Planning
Commission of India leading to successful implementation of most of its recommendations.
Then it turned out that during the 2008 economic crisis of major economies worldwide,
performance of Indian banking sector was far better than their international counterparts. This
was also credited to the successful implementation of the recommendations of the Narasimham
Committee-II with particular reference to the capital adequacy norms and the recapitalization ofthe public sector banks. The impact of the two committees has been so significant that elite
politicians and financial sectors professionals have been discussing these reports for more than a
decade since their first submission applauding their positive contribution over the years.
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CONCLUSION:
Since the banking reforms of 1991, there have been significant favorable changes
in Indias highly regulated banking sector. This project has assessed the impact of the reforms by
examining several hypotheses. It concludes that the banking reforms have had a moderately
positive impact on reducing the concentration of the banking sector (at the lower end) and
improving performance.
Allowing banks to engage in non-traditional activities has contributed to
improved profitability and cost and earnings efficiency of the whole banking sector, including
public-sector banks. By contrast, investment in government securities has lowered the
profitability and cost efficiency of the whole banking sector, including public-sector banks.
Lending to priority sectors and the public-sector has not had a negative effect on profitability and
cost efficiency, contrary to our expectations.
Further, foreign banks (and private domestic banks in some cases) have generally performed
better than other banks in terms of profitability and income efficiency. This suggests that
ownership matters and foreign entry has a positive impact on banking sector restructuring.