Banking Sector Reforms & Acts in India

Narasimham Committee I (1991)

This committee was headed by Mr. M. Narasimham, who was the 13th Governor of RBI. This committee was appointed against the backdrop of the Balance of Payment Crisis. It was set up to analyze all factors related to financial system and give recommendation to improve its efficiency and productivity. Some of the important recommendations of the committee were:

• Interest Rate Deregulation: The Committee observed that the prevailing structure of administered rates was highly complex and rigid and called for deregulating it so that it reflects the emerging market conditions. However, it warned against instant deregulation and suggested gradual deregulation over a period of time.

• Structural Reorganization of Banks: the Committee believed that the structure should consist of 3-4 Banks (including SBI) becoming International Banks, 8 to 10 national banks with a nationwide network of branches engaged in universal banking, Local banks operations would be generally confined to a specific region, Rural banks (including RRBs) to the rural areas predominantly engaged in financing of agriculture and allied activities.

• Establishment of ARF tribunal: The committee recommended the establishment of an Asset Reconstruction Fund (ARF) which would take over the proportion of the bad and doubtful debts from the banks and financial institutes. All bad and doubtful debts of the banks were to be transferred in a phased manner to ensure smooth and effective functioning of the ARF. The committee also suggested the formation of special tribunals to recover loans granted by the bank

• Allowing Banks to raise Capital: The Committee recommended that profitable banks and banks with good reputation should be permitted to raise capital from the public through the capital market. Regarding other banks, the government should subscribe to their capital or give a loan, which should be treated as a subordinate debt, to meet their capital requirements.

• Reduction in CRR and SLR.

Narasimham Committee II

It was setup by the Finance Ministry of the Government of India under the chairmanship of Mr. M. Narasimham in 1998. Its aim was to review the progress of the implementation of the banking reforms since 1992 with the aim of further strengthening the financial institutions of India. The Committee’s Report focused on issues like size of banks and capital adequacy ratio.

• Need for a Stronger Banking System: It recommended the merger of strong banks, which will have a “multiplier effect” on industry. It also supported that two or three large strong banks be given international or global platform to work on.

• Stricter norms for NPAs: Some of the PSBs had NPAs as high as 20 percent of their assets. For successful rehabilitation of these banks, the committee recommended Narrow Banking Concept. As per this, the weak banks were to be allowed to place their funds only in short term and risk free assets.

• Greater Autonomy for the PSBs: Greater autonomy was proposed for the public sector banks in order for them to function with equivalent professionalism as their international counterparts. The Committee recommended: GoI equity in nationalized banks be reduced to 33% , RBI to relinquish its seats on the board of directors of these banks, 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

• Capital Adequacy Norms: To improve the inherent strength of the Indian banking system the committee recommended that the Government should raise the prescribed capital adequacy norms to improve their Risk absorption capacity. The committee targeted raising the capital adequacy ratio to 9% by 2000 and 10% by 2002. The Committee recommended penal provisions for banks that fail to meet these requirements.

Implementation of Recommendations

To implement these recommendations, the RBI in Oct 1998, initiated the second phase of financial sector reforms on the lines of Narasimham Committee-II report. RBI raised Capital Adequacy Ratio by 1% and tightened the prudential norms for provisioning and asset classification in a phased manner (discussed later). It also targeted to bring the capital adequacy ratio to 9% by March 2001.

In October 1999 criteria for “autonomous status” was identified by March 1999 and 17 banks were considered eligible for autonomy. The Committee’s recommendations let to introduction of a new legislation in 2002, Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002(SARAFESI Act 2002). Some of the recommendations like reduction in Governments equity to 33%, the issue of greater professionalism and
independence of the board of directors of public sector banks are still awaiting Government follow-through.

During the 2008 economic crisis, performance of Indian banking sector was far better than their international counterparts. This was credited to the successful implementation of the recommendations of the Narasimham Committee-II with particular reference to the capital adequacy norms and the recapitalization of the public sector banks. Impact of the two committees has been so significant that the financial-economic sector professionals have been applauding there positive contribution.

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