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BANKING SECTOR REFORMS

BANKING SECTOR REFORMS

  • Since nationalization of banks in 1969, the banking sector had been dominated by the public sector. There was financial repression, role of technology was limited, no risk management etc.
  • This resulted in low profitability and poor asset quality. The country was caught in deep economic crises. The Government decided to introduce comprehensive economic reforms.
  • Banking sector reforms were part of this package. In August 1991, the Government appointed a committee on financial system under the chairmanship of M. Narsimhan.

First phase of Banking Sector Reforms/ Narsimhan Committee Report – 1991

To promote healthy development of financial sector, the Narsimhan Committee made the following recommendations:‑

  • Establishment of 4 tier hierarchy for banking structure with 3 to 4 large banks (including SBI) at top and Rural banks at bottom.
  • The supervisory functions over banks and financial institutions can be assigned to a quasi-autonomous body sponsored by RBI.
  • Phased reduction in statutory liquidity ratio.
  • Phased achievement of 8% capital adequacy
  • Abolition of branch licensing
  • Proper classification of assets and full disclosure of accounts of banks and financial institutions.
  • Deregulation of Interest rates.
  • Delegation of direct lending activity of IDBI to a separate corporate body.
  • Competition among financial institutions on participating approach.
  • Setting up Asset Reconstruction Fund to take over a portion of loan portfolio of banks whose recovery has become difficult.

Measures taken by the Government on Narsimhan Committee recommendations:‑

On the recommendations of Narsimhan Committee, following measures were dertaken by government since 1991:‑

Lowering SLR And CRR The high SLR and CRR reduced the profits of the banks. Lowering these rates left more funds with banks for allocation to agriculture, industry, trade etc. The purpose of this was to release the funds locked up with RBI.

Prudential Norms The purpose of prudential norms included proper disclosure of income, classification of assets and provision for Bad debts so as to ensure that the books of commercial banks reflected the accurate and correct picture of financial position. Prudential norms required banks to make 100% provision for all Non­performing Assets (NPAs).

Capital Adequacy Norms (CAN) Capital Adequacy ratio is the ratio of minimum capital to risk asset ratio.

Deregulation of Interest Rates

  • Scheduled Commercial banks were given the freedom to set interest rates on their deposits subject to minimum floor rates and maximum ceiling rates.
  • The prime lending rate of SBI and other banks on general advances of over Rs. 2 lakhs was reduced.
  • Rate of Interest on bank loans above Rs. 2 lakhs was fully decontrolled.
  • The interest rates on deposits and advances of all Co-operative banks were deregulated subject to a minimum lending rate of 13%.

Competition From New Private Sector Banks

  • Banking was opened to private sector due to which the new private sector banks had already started functioning.
  • These new private sector banks were allowed to raise capital contribution from foreign institutional investors up to 20% and from NRIs up to 40%. This led to increased competition.

Access To Capital Market

  • The Banking Companies (Acquisition and Transfer of Undertakings) Act was amended to enable the banks to raise capital through public issues.  BANKING SECTOR REFORMS
  • This was subject to the provision that the holding of Central Government would not fall below 51% of paid-up-capital. SBI had already raised substantial amount of funds through equity and bonds.

Freedom Of Operation

  • Scheduled Commercial Banks were given freedom to open new branches and upgrade extension counters, after attaining capital adequacy ratio and prudential accounting norms.
  • The banks are also permitted to close non-viable branches other than in rural areas.

Supervision of Commercial Banks

  • The RBI set up a Board of Financial Supervision with an Advisory Council to strengthen the supervision of banks and financial institutions.
  • In 1993, RBI established a new department known as Department of Supervision as an independent unit for supervision of commercial banks.

Second phase of Reforms of Banking Sector/ Narsimhan Committee Report 1998

  • To make banking sector stronger the government appointed a second Committee on Banking Sector Reforms again under the Chairmanship of M. Narsimhan.
  • It submitted its report in April 1998. The Committee placed greater importance on structural measures and improvement in standards of disclosure and levels of transparency.  BANKING SECTOR REFORMS

Following were the recommendations of Narsimhan Committee:‑

  • The Committee suggested a strong banking system especially in the context of Capital Account Convertibility (CAC). The Committee cautioned against the merger of strong banks with weak ones as this may have negative effect on stronger banks.  BANKING SECTOR REFORMS
  • It suggested that 2 or 3 large banks should be given international orientation and global character.
  • There should be 8 to10 national banks and large number of local banks.
  • It suggested new and higher norms for capital adequacy.
  • To take over the bad debts of banks, the Committee suggested setting up of an Asset Reconstruction Fund.
  • A Board for Financial Regulation and Supervision (BFRS) can be set up to supervise the activities of banks and financial institutions.
  • It suggested an urgent need to review and amend the provisions of RBI Act, Banking Regulation Act, etc. to bring them in line with the then needs of industry.
  • Net Non-performing Assets for all banks was to be brought down to 3% by 2002.
  • Rationalization of bank branches and staff was emphasized. Licensing policy for new private banks was to be continued.
  • Foreign banks were to be allowed to set up subsidiaries and joint ventures.  BANKING SECTOR REFORMS

ALSO READ : https://www.brainyias.com/iasbuzz/public-sector-banks/

Indian Economy

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