Banking sector reforms

Banking Sector Reforms in India refer to the series of changes implemented to modernize and strengthen the Indian banking system.

These reforms were initiated in the early 1990s as part of India’s overall economic liberalization and has been ongoing since then.

Most of these reforms have been carried out in the Public Sector Banks (PSBs), though some of them have also been applicable for Private Sector Banks.

The Narasimham Committee was established under former RBI Governor M. Narasimham in August 1991 to look into all aspects of the financial system in India.

The report of this committee had comprehensive recommendations for financial sector reforms including the banking sector and capital markets. In broad acceptance to this committee, the government announced slew of reforms.

• Statutory Liquidity Ratio (SLR) is brought down in a phased manner to 25percent (the minimum prescribed under the law) over a period of about five years to give banks more funds to carry business and to curtail easy and captive finance.
• The RBI should reduce Cash Reserve Ratio (CRR) from its present high level to 10 percent.
• The priority sector should be scaled down from present high level of 40 percent of aggregate credit to 10 percent. Also the priority sector should be redefined.
• Interest rates to be deregulated to reflect emerging market conditions.
• Banks whose operations have been profitable is given permission to raise fresh capital from the public through the capital market.
• Balance sheets of banks and financial institutions are made more transparent.
• Government should indicate that there would be no further nationalisation of banks, the new banks in the private sector should be welcome subject to normal requirements of the RBI, branch licensing should be abolished and policy towards foreign banks should be more liberal.

• Statutory Liquidity Ratio (SLR) on incremental Net Domestic and Time Liabilities (NDTL) reduced from 38.5 percent in 1991-92 to 28 percent by December 1996.
• Effective Cash Reserve Ratio (CRR) on the NDTL reduced from 14 percent to 10 percent in January 1997.
• New prudential norms for income recognition, classification of assets and provisioning of bad debts introduced in 1992.
• The SBI and some other nationalised banks have been allowed to seek capital market access.
• Banks given freedom to open new branches and upgrade extension counters on attaining capital adequacy norms and prudential accounting standards. They are permitted to close non-viable branches other than in rural areas.

In 1998 the government appointed yet another committee under the chairmanship of Mr. Narsimham. It is better known as the Banking Sector Committee. It was told to review the banking reform progress and design a programme for further strengthening the financial system of India. Its recommendations are:

Strengthening Banks in India: The committee considered the stronger banking system in the context of the Current Account Convertibility ‘CAC’. It thought that Indian banks must be capable of handling problems regarding domestic liquidity and exchange rate management in the light of CAC. Thus, it recommended the merger of strong banks which will have ‘multiplier effect’ on the industry.

Narrow Banking: Those days many public sector banks were facing a problem of the Non-performing assets (NPAs). Some of them had NPAs were as high as 20 percent of their assets. Thus for successful rehabilitation of these banks it recommended ‘Narrow Banking Concept’ where weak banks will be allowed to place their funds only in short term and risk free assets

Capital Adequacy Ratio: 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 will further improve their absorption capacity also. Currently the capital adequacy ratio for Indian banks is at 9 percent.

Bank ownership: As it had earlier mentioned the freedom for banks in its working and bank autonomy, it felt that the government control over the banks in the form of management and ownership and bank autonomy does not go hand in hand and thus it recommended a review of functions of boards and enabled them to adopt professional corporate strategy.

Review of banking laws: The committee considered that there was an urgent need for reviewing and amending main laws governing Indian Banking Industry like RBI Act, Banking Regulation Act, State Bank of India Act, Bank Nationalisation Act, etc. This upgradation will bring them in line with the present needs of the banking sector in India.

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.

Most of the recommendations of the Committee have been acted upon although some major recommendations are still awaiting action from the Government of India.

Latest action taken by the government is merger of banks, even though it took several years to implement that reform.

The Reserve Bank of India constituted a Committee in 2011 to look into banking services rendered to retail and small customers, including pensioners and also to look into the system of grievance redressal mechanism prevalent in banks, its structure and efficacy and suggest measures for expeditious resolution of complaints.

Some of the important reforms suggested:

• A guaranteed payment of up to Rs 5 lakh (raised from Rs 1 lakh) under deposit insurance to an account holder if a bank fails.
• No liability on customer for losses in ATM and online transactions
• Instant blocking of ATM card through SMS for lost/misused cards
• Pensioners to be allowed to submit life certificate in any bank branch
• A third-party Know Your Customer data bank
• Compensation for delayed return or loss of title deeds in the custody of banks
• Prepaid instruments worth up to Rs 50,000 for frequent travellers
• Compensation for delayed return or loss of title deeds in the custody of banks

An expert committee appointed to examine the current monetary policy framework of the Reserve Bank of India. It is Headed by Urjit Patel, then Deputy Governor of the Reserve Bank of India (RBI). Its objective is to strengthen Monetary Policy Framework of RBI.

Recommendations:

• Use CPI as a mean to measure inflation of the country not WPI
• Target: 4% CPI, +/-2% Band [control inflation in 2-6% range.]
• Tool: Repo as policy rate, +/-1% spread in R-Repo & MSF,
• Strategy: keep Repo rate higher than CPI
• RBI to fix accountability in monetary policy making – Form a Monetary committee of 5 members including
  • RBI Governor,
  • Deputy Governor,
  • RBI’s Executive Director,
  • Two outsiders/External members
    • Noted Economists, finance experts etc., who are not office bearers in RBI.
    • Term: three years + Not eligible for re-appointment
• MPC must issue a public statement & every MPC member must sign it. This statement will contain Why did we fail? (Reasons),How will we fix it (Future action proposed), By when will we fix it? (Timeframe).
• Government to help RBI to achieve set targets
• Eliminate administered prices (MSP on food grains, LPG cylinders)
• Eliminate administered wages (MNREGA)
• Eliminate administered interest rates (interest subvention given to farmers)
• Implement Vijay Kelkar Committee’s recommendations on fiscal consolidation.
• Religiously follow the guidelines & targets of FRBM.

• Union Government and RBI signed an agreement on Monetary Policy Framework and Finance Minister to set inflation targets for RBI. It will specify the inflation targets for RBI, contrary to the recommendation of Urjit Patel Committee until now, the RBI has the sole power to regulate the monetary policy & set inflation targets. Presently, Union Government and RBI give inflation estimates and do not set targets. But as per this agreement government has set a target for RBI to bring down inflation –
• Below 6 % by January 2016
• 4 percent +/-2 percentage points for 2016-2017 & all subsequent year This agreement mentions that if RBI fails to meet the target, it will –
• Report to the government with the reasons for the failure to achieve the target
• Propose remedial actions to be taken.
• Further estimate the time period within which the failed target would be achieved. As per the agreement, this Monetary Policy Framework will be monitored by the RBI and it is binding on Union Government to take proactive measures for price control.
• From April 1, 2014 will be measured on CPI based on Urjitpatel committee recommendations.

The “Committee on Comprehensive Financial Services for Small Businesses and Low Income Households” was set up by the RBI under the chairmanship of Nachiket Mor. In its final report, the Committee has outlined six vision statements for full financial inclusion and financial deepening in India:

• Universal Electronic Bank Account (UEBA): Each Indian resident, above the age of eighteen years, would have an individual, full-service, safe, and secure electronic bank account.
• Ubiquitous Access to Payment Services and Deposit Products at Reasonable Charges: The Committee envisions that every resident in India would be within a fifteen minute walking distance of a payment access point.
• Sufficient Access to affordable Formal Credit: Each low-income household and small-business would have access to a formally regulated lender that is capable of assessing and meeting their credit needs. Such a lender must also be able to offer them a full-range of suitable credit products at an affordable price.
• Universal Access to a Range of Deposit and Investment Products at Reasonable Charges: Each low-income household and small-business would have access to providers that can offer them suitable investment and deposit products. Such services must be available to them at reasonable charges.
• Universal Access to a Range of Insurance and Risk Management Products at Reasonable Charges: Each low-income household and small business would have access to providers that have the ability to offer them suitable insurance and risk management products. These products must at minimum allow them to manage risks related to:
• Commodity price movements;
• Longevity, disability, and death of human beings;
• Death of livestock;
• Rainfall;
• Damage to property.
• Right to Suitability: Each low-income household and small-business would have a legally protected right to be offered only suitable financial services. She will have the right to seek legal redress if she feels that due process to establish Suitability was not followed or that there was gross negligence.

The key recommendations are:

• Providing a universal bank account to all Indians above the age of 18 years by January 1, 2016. To achieve this, a vertically differentiated banking system with payments banks for deposits and payments and wholesale banks for credit outreach. These banks need to have Rs.50 crore by way of capital, which is a tenth of what is applicable for new banks that are to be licensed.
• Aadhaar will be the prime driver towards rapid expansion in the number of bank accounts.
• Monitoring at the district level such as deposits and advances as a percentage of gross domestic product (GDP).
• Adjusted 50 per cent priority sector lending target with adjustments for sectors and regions based on difficulty in lending.

Mission Indradhanush is a 7-pronged plan to address the challenges faced by public sector banks (PSBs). Many of the measures taken were suggested by P J Nayak committee on Banking sector reforms as indicated.

The 7 parts include appointments, Banks board bureau, capitalisation, de-stressing, empowerment, framework of accountability and governance reforms (ABCDEFG).

1. Appointments – separation of posts of CEO and MD to check excess concentration of power and smoothen the functioning of banks; also induction of talent from private sector (recommendation of P J Nayak Committee)
2. Bank Boards Bureau – BBB will be a super authority (Autonomous Body) of eminent professionals and officials for public sector banks (PSBs). It will replace the Appointments Board of Government.

• It will advise the banks on how to raise funds and how to go ahead with mergers and acquisitions.
• It will also hold bad assets of public sector banks.
• It will be a step into eventual transition of the bureau into a bank holding company. It will separate the functioning of the banks from the government by acting as a middle link.
• The bureau will have three ex-officio members and three expert members, in addition to the Chairman.

3. Capitalisation

• Capitalisation of the banks by inducing Rs 70,000 crore into the banks in the next 4 years
• Banks are in need of capitalisation due to high NPAs and due to need to meet the new BASEL- III norms

4. De-stressing: Solve issues in the infrastructure sector to check the problem of stressed assets in banks.
5. Empowerment: Greater autonomy for banks; more flexibility for hiring manpower.
6. Framework of accountability: The banks will be assessed on the basis of new key performance indicators. These quantitative parameters such as NPA management, return on capital, growth and diversification of business and financial inclusion as well as qualitative parameters such as human resource initiatives and strategic steps to improve assets quality.
7. Governance Reforms: GyanSangam conferences between government officials and bankers for resolving issues in banking sector and chalking out future policy.

Government plans to come out with ‘Indradhanush 2.0’, a comprehensive plan for recapitalisation of public sector lenders, with a view to make sure they remain solvent and fully comply with the global capital adequacy norms, Basel- III. ‘Indradhanush 2.0’ will be finalised after completion of the Asset Quality Review (AQR) by the Reserve Bank, which is likely to be completed by March-end.