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Narasimham committee on banking sector reforms wikipedia
1. Narasimham Committee on Banking
Sector Reforms
From the 1991 India economic crisis to its status of third largest economy in the world by 2011, India has
grown significantly in terms of economic development. So has its banking sector. During this period,
recognising the evolving needs of the sector, the Finance Ministry of Government of India (GOI) set up
various committees with the task of analysing India's banking sector and recommending legislation and
regulations to make it more effective, competitive and efficient.[1] Two such expert Committees were set up
under the chairmanship of M. Narasimham. They submitted their recommendations in the 1990s in
reports widely known as the Narasimham Committee-I (1991) report and the Narasimham Committee-
II (1998) Report. These recommendations not only helped unleash the potential of banking in India, they
are also recognised as a factor towards minimising the impact of global financial crisis starting in 2007.
Unlike the socialist-democratic era of the 1960s to 1980s, India is no longer insulated from the global
economy and yet its banks survived the 2008 financial crisis relatively unscathed, a feat due in part to
these Narasimham Committees.[2]
Background
Recommendations of the Committee
Autonomy in Banking
Reform in the role of RBI
Stronger banking system
Non-performing assets
Capital adequacy and tightening of provisioning norms
Entry of foreign banks
Implementation of recommendations
Criticism
Reception
References
During the decades of the 60s and the 70s, India nationalised 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 liberalisation 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 Bank as part of their loan
Contents
Background
2. conditionality to India in 1991).[3] 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.[4] 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.[3] The first Narasimhan Committee
(Committee on the Financial System – CFS) was appointed by Manmohan Singh as India's Finance
Minister on 14 August 1991,[1][5] and the second one (Committee on Banking Sector Reforms)[6] was
appointed by P.Chidambaram[7] as Finance Minister in December 1997.[8] Subsequently, the first one
widely came to be known as the Narasimham Committee-I (1991) and the second one as Narasimham-II
Committee(1998).[9][10] 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,
organisation, functions and procedures of the financial systems and to recommend improvements in their
efficiency and productivity. The Committee submitted its report to the Finance Minister in November 1991
which was tabled in Parliament on 17 December 1991.[6]
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.[4] It focussed
on issues like size of banks and capital adequacy ratio among other things.[9] M. Narasimham, Chairman,
submitted the report of the Committee on Banking Sector Reforms (Committee-II) to the Finance Minister
Yashwant Sinha in April 1998.[4][9]
The 1998 report of the Committee to the GOI made the following major recommendations:
Greater autonomy was proposed for the public sector banks 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 banking systemname="Hindu3">"Going ahead with bank mergers" (htt
p://www.thehindubusinessline.in/2010/01/29/stories/2010012951380800.htm).
Thehindubusinessline.in. 29 January 2010. Retrieved 19 February 2011. </ref>[11] 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 the board 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.[4] 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 the government equity.
Recommendations of the Committee
Autonomy in Banking
3. To implement this, criteria for autonomous status was identified by March 1999 (among other
implementation measures) and 17 banks were considered eligible for autonomy.[12] But some
recommendations like reduction in Government's equity to 33%,[11][13] the issue of greater professionalism
and independence of the board of directors of public sector banks is still awaiting Government follow-
through and implementation.[14]
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.[6][12] Second,
the Committee proposed a segregation of the roles of RBI as a regulator of banks and owner of bank.[15] 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 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 upgradation in
technology and legal/procedural changes to facilitate electronic transfer.[16] 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 finalised in 2007–08 itself.[17]
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.[4][9] This proposal had been severely criticized by the RBI employees
union.[18] The Committee recommended the use of mergers to build the size and strength of operations for
each bank.[19] 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 revitalise themselves.[6] Given the large
percentage of non-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.
There were a string of mergers in banks of India during the late 90s and early 2000s, encouraged strongly
by the Government of India|GOI in line with the Committee's recommendations.[20] However, the
recommended degree of consolidation is still awaiting sufficient government impetus.[14]
Non-performing assets had been the single largest cause of irritation of the banking sector of India.[4]
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
Reform in the role of RBI
Stronger banking system
Non-performing assets
4. and thus it recommended it to be phased out.[10] Subsequently, the Narasimham Committee-II also
highlighted the need for 'zero' non-performing assets for all Indian banks with International presence.[10]
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 bad debts of banks, allowing them to start on a clean-slate.[4][21][22] The option of
recapitalisation through budgetary provisions was ruled out. Overall the committee wanted a proper
system to identify and classify NPAs,[6] NPAs to be brought down to 3% by 2002[4] and for an independent
loan review meachnism for improved management of loan portfolios.[6] The committee's
recommendations let to introduction of a new legislation which was subsequently implemented as the
Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002 and
came into force with effect from 21 June 2002.[23][24][25]
To improve the inherent strength of the Indian banking system the committee recommended that the
Government should raise the prescribed capital adequacy norms.[9] 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.[4][6] 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.[12]
Capital adequacy and tightening of provisioning norms
5. 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.[26] The RBI targeted to bring the capital adequacy ratio to 9% by March 2001.[27] 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.[12]
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.[4]
In 1998, RBI Governor Bimal Jalan informed the banks that the RBI had a three to four-year perspective
on the implementation of the Committee's recommendations.[26] Based on the other recommendations of
the committee, the concept of a universal bank was discussed by the RBI and finally ICICI bank became
the first universal bank of India.[16][28][29] The RBI published an "Actions Taken on the
Recommendations" report on 31 October 2001 on its own website. Most of the recommendations of the
Committee have been acted upon (as discussed above) although some major recommendations are still
awaiting action from the Government of India.[30]
There were protests by employee unions of banks in India against the report. The Union of RBI employees
made a strong protest against the Narasimham II Report.[18] There were other plans by the United Forum
of Bank Unions (UFBU), representing about 1.3 million bank employees in India, to meet in Delhi and to
work out a plan of action in the wake of the Narasimham Committee report on banking reforms. The
committee was also criticised in some quarters as "anti-poor". According to some, the committees failed to
recommend measures for faster alleviation of poverty in India by generating new employment.[3] This
caused some suffering to small borrowers (both individuals and businesses in tiny, micro and small
sectors).
Initially, the recommendations were well received in all quarters, including the Planning Commission of
India leading to successful implementation of most of its recommendations.[31] 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 recapitalisation of the public sector banks.[2] 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
Entry of foreign banks
Implementation of recommendations
Criticism
Reception
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