FINANCIAL REFORMS IN INDIAN BANKING SECTORS
Mr. M. NALLAKANNU
Assistant
Professor of Commerce
K.R.
COLLEGE OF ARTS
K.R. NAGAR,
KOVILPATTI -628503.
ABSTRACT
The Banking system in India India India
Key
Words: Banking Sector, Reforms, Economy, Inflation, Growth.
INTRODUCTION:
Banking
system consists of central banks, commercial banks, co-operative banks and
foreign banks etc., which are involved in the banking operation of the country.
The financial system deals about money market, capital market foreign exchange
market and the various sources for rising funds. It also includes financial
instrument. With changing world trade, there has been a many changes both in
the banking and financial systems. Added with many reforms in banking sectors
recommended by Mr. Narasiman Commission – I 1991 provided the blue print for
the first generation reforms of the financial sector, the period 1992-97
witnessed the laying of the foundations for reforms in the banking system. This
period the implementation of prudential norms (relating to capital adequacy,
CRR, SLR, income recognition, asset classification and provisioning, exposure
norms etc). The structural changes accomplished during the period provided
foundation of further reforms. Against such backdrop, the Report of the
Narasiman Committee- II in 1998 provided the road map of the second generation
reforms processes. Y.V. Reddy noted that
the first generation reforms were undertaken early in the reform cycle, and the
reforms in the financial sector were initiated in a well structured, sequenced
and phased manner with cautious and proper sequencing, mutually reinforcing
measures; complimentarily between forms in banking sector and changes in
fiscal, external and monetary policies, developing financial infrastructure and
developing markets. By way of visible
impact, one finds the presence of a diversified banking system. Another
important aspect is that apart from the growth of banks and commercial banks
there are various other financial intermediaries including mutual funds. NBFCs,
primary dealers housing financing companies etc., the roles played by the
commercial banks in promoting these institutions are equally significant. Other
important developments are:
1. Financial regulation through statutory
pre-emotions (Bank rate, deposit rate, Credit Reserve Ration, Statutory
Liquidity ratio) has been lowered while stepping up prudential regulations at
the same time.
2. Interest
rates have been deregulated, allowing banks the freedom to determine deposits
and lending rates.
3. Steps
have been initiated to strengthen public sector banks, through increasing their
autonomy recapitalization from the fiscal, several banks capital base has been
written off and some have even returned capital to govt. Allowing new private
sector banks and more liberal entry of foreign banks has infused competition.
4. A set of
prudential measures have been stipulated to impart greater strength to the
banking system and also, ensure their safety and soundness with the objective
of moving towards international practices.
5. Measures
have also been taken to broaden the ownership base of PSB; consequently, the
private sector holding has gone up, ranging from 23% to 43%.
6. The
banking sector has also witnessed greater levels of transparency and standards
of disclosure.
BANKING SECTOR
REFORMS:
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, Organizations and Functioning of the
financial system. The Narasimham
Committee report, submitted to the then finance minister, Man Mohan 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.
The main recommendations of the Committee were: -
v
Reduction of Statutory
Liquidity Ratio (SLR) to 25 per cent over a period of five years
v
Progressive reduction
in Cash Reserve Ratio (CRR)
v
Phasing out of
directed credit programmes and redefinition of the priority sector
v
Stipulation of minimum
capital adequacy ratio of 4 per cent to risk weighted assets
v
Adoption of uniform
accounting practices in regard to income recognition, asset classification and
provisioning against bad and doubtful debts
v
Imparting transparency
to bank balance sheets and making more disclosures
v
Setting up of special
tribunals to speed up the process of recovery of loans
v
Setting up of Asset
Reconstruction Funds (ARFs) to take over from banks a portion of their bad and
doubtful advances at a discount
v
Restructuring of the
banking system, so as to have 3 or 4 large banks, which could become
international in character, 8 to 10 national banks and local banks confined to
specific regions. Rural banks, including RRBs, confined to rural areas
v
Abolition of branch
licensing
v
Liberalizing the
policy with regard to allowing foreign banks to open offices in India
v
Rationalization of
foreign operations of Indian banks
v
Giving freedom to
individual banks to recruit officers
v
Inspection by
supervisory authorities based essentially on the internal audit and inspection
reports
v
Ending duality of
control over banking system by Banking Division and RBI
v
A separate authority
for supervision of banks and financial institutions which would be a
semi-autonomous body under RBI
v
Revised procedure for
selection of Chief Executives and Directors of Boards of public sector banks
v
Obtaining resources
from the market on competitive terms by DFIs
v
Speedy liberalization
of capital market
ECONOMIC REFORMS OF THE BANKING SECTOR IN INDIA
The
Government of India accepted all the major recommendation of Mr. Narasiman Committee
on banking sector and started implementing them. The banking reforms measures
have been briefed here under:
1. Reduced CRR
and SLR:
The Cash
Reserve Ratio (CRR) and Statutory Liquidity Ratio (SLR) are gradually reduced
during the economic reforms period in India India
2. Deregulation
of Interest Rate:
During the
economics reforms period, interest rates of commercial banks were deregulated.
Banks now enjoy freedom of fixing the lower and upper limit of interest on
deposits. Interest rate slabs are reduced from Rs.20 Lakhs to just Rs. 2 Lakhs.
Interest rates on the bank loans above Rs.2 lakhs are full decontrolled. These
measures have resulted in more freedom to commercial banks in interest rate
regime.
3. Fixing
prudential Norms:
In order
to induce professionalism in its operations, the RBI fixed prudential norms for
commercial banks. It includes recognition of income sources. Classification of
assets, provisions for bad debts, maintaining international standards in
accounting practices, etc. It helped banks in reducing and restructuring
Non-performing assets (NPAs).
4. Introduction
of CRAR:
Capital to
Risk Weighted Asset Ratio (CRAR) was introduced in 1992. It resulted in an
improvement in the capital position of commercial banks, all most all the banks
in India has reached the Capital Adequacy Ratio (CAR) above the statutory level
of 9%.
5. Operational
Autonomy:
During the
reforms period commercial banks enjoyed the operational freedom. If a bank
satisfies the CAR then it gets freedom in opening new branches, upgrading the
extension counters, closing down existing branches and they get liberal lending
norms.
6. Banking
Diversification:
The Indian
banking sector was well diversified, during the economic reforms period. Many
of the banks have stared new services and new products. Some of them have
established subsidiaries in merchant banking, mutual funds, insurance, venture
capital, etc which has led to diversified sources of income of them.
7. New Generation
Banks:
During the
reforms period many new generation banks have successfully emerged on the
financial horizon. Banks such as ICICI Bank, HDFC Bank, UTI Bank have given a
big challenge to the public sector banks leading to a greater degree of
competition.
8. Improved
Profitability and Efficiency:
During the
reform period, the productivity and efficiency of many commercial banks has
improved. It has happened due to the reduced Non-performing loans, increased
use of technology, more computerization and some other relevant measures
adopted by the government.
FIRST
PHASE OF BANKING SECTOR REFORMS:
The first phase
of banking sector reforms essentially focused on the following:
1.)
Reduction in SLR & CRR
2.)
Deregulation of interest rates
3.)
Transparent guidelines or norms for entry and exit of private sector banks
4.)
Public sector banks allowed for direct access to capital markets
5.)
Branch licensing policy has been liberalized
6.)
Setting up of Debt Recovery Tribunals
7.) Asset
classification and provisioning
8.)
Income recognition
9.) Asset
Reconstruction Fund (ARF)
SECOND
PHASE OF BANKING SECTOR REFORMS:
In spite of the optimistic views about the growth of
banking industry in terms of branch expansion, deposit mobilization etc,
several distortions such as increasing NPAs and obsolete technology crept into
the system, mainly due to the global changes occurring in the world economy. In
this context, the government of India
appointed second Narasimham Committee under the chairmanship of Mr. M.
Narasimham to review the first phase of banking reforms and chart a programme
for further reforms necessary to strengthen India
As the process of second banking
sector reforms is going on since 1999, one may say that there is an improvement
in the performance of banks. However, there have been many changes and
challenges now due to the entry of our banks into the global market.
THIRD
BANKING SECTOR REFORMS AND FRESH OUTLOOK:
Rethinking for financial sector reforms have to be accorded, restructuring
of the public sector banks in particular, to strengthen the Indian financial
system and make it able to meet the challenges of globalization. The on-going
reform process and the agenda for third reforms will focus mainly to make the
banking sector reforms viable and efficient so that it could contribute to
enhance the competitiveness of the real economy and face the challenges of an
increasingly integrated global financial architecture. When we take this
evidence together, where does it leave us? There are obvious problems with the
Indian banking sector, ranging from under-lending to unsecured lending, which
we have discussed at some length. There is now a greater awareness of these
problems in the Indian government and a willingness to do something about them.
Finally, one potential
disadvantage of privatization comes from the risk of bank failure. In the past
there have been cases where the owner of the private bank stripped its assets,
and declared that it cannot honor its deposit liabilities. The government is,
understandably, reluctant to let banks fail, since one of the achievements of
the last forty years has been to persuade people that their money is safe in
the banks. Therefore, it has tended to take over the failed bank, with the resultant
pressure on the fiscal deficit. Of course, this is in part a result of poor
regulation–the regulator should be able to spot a private bank that is
stripping its assets. Better enforced prudential regulations would considerably
strengthen the case for privatization.
In
the end the key to banking reform may lie in the internal bureaucratic reform
of banks, both private and public. In part this is already happening as many of
the newer private banks (like HDFC, ICICI) try to reach beyond their traditional
clients in the housing, consumer finance and blue-chip sectors. This will require a set of smaller step
reforms, designed to affect the incentives of bankers in private and public
banks. A first step would be to make lending rules more responsive to current
profits and projections of future profits. This may be a way to both targets
better and guard against potential NPAs, largely because poor profitability
seems to be a good predictor of future default. It is clear however that
choosing the right way to include profits in the lending decision will not be
easy.
The
objectives would be to create three categories of firms: (1) Profitable to
highly profitable firms. Within this category lending should respond to
profitability, with more profitable firms getting a higher limit, even if they
look similar on the other measures. (2) Marginally profitable to loss-making
firms that used to be highly profitable in the recent past but have been hit by
a temporary shock (e.g. an increase in the price of cotton because of crop
failures, etc.). For these firms the existing rules for lending might work
well. (3) Marginally profitable to loss-making firms that have been that way
for a long time or have just been hit by a permanent shock (e.g., the removal
of tariffs protecting firms producing in an industry in which the Chinese have
a huge cost advantage).
CONCLUSION:
It could be noted that there has been no banking crisis at
the same time, efficiency of banking system as a whole, measured by declining
spread has improved. This is not say that they have no challenges. There are
emerging challenges, which appear in the forms of consolidation;
recapitalization, prudential regulation weak banks, and non-performing assets,
legal framework etc needs urgent attention.
This paper concludes that, from a regulatory perspective, the recent
developments in the financial sector have led to an appreciation of the
limitations of the present segmental approach to financial regulation and
favors adopting a consolidated supervisory approach to financial regulation and
supervision, irrespective of its structural design.
RBI should appoint another committee to
evaluate the on-going banking sector reforms and suggest third phase of the
banking sector reforms in the light of above said recommendations. Need of the
hour is to provide some effective measures to guard the banks against financial
fragilities and vulnerability in an environment of growing financial
integration, competition and global challenges.
REFERENCES:
1. S.Sankaran,
Indian Economy, Margham publications, Chennai.
2.
B.Santhanam, Banking and Financial System, Margham publications,
Chennai.
3. Reddy
Y. V. (2002), “Monetary and Financial Sector Reforms in India : A Practitioner’s
Perspective”, The Indian Economy Conference, Program on Comparative Economic Development (PCED) at Cornell University , USA
4. Jalan
B (2000), Agenda for Banking in the New Millenium, Reserve Bank of India
Bulletin, New Delhi
