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Narasimham Committee on Banking Sector Reforms

From the 1991 India economic crisis to its status of fourth largest economy in the
world by 2010, India has grown significantly in terms of economic development. So
has its banking sector. During this period, recognizing the evolving needs of the
sector, the Finance Ministry of Government of India (GOI) set up various committees
with the task of analyzing 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 recognized as a factor towards minimizing 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.


During the decades of the 60s and the 70s, India nationalisated 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 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 14th August 1991,[5]
[1] 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, organization, 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 17th 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.

Recommendations of the Committee

The 1998 report of the Committee to the GOI made the following major

[edit]Autonomy in Banking

Greater autonomy was proposed for the public sector banks in order for them to
function with equivalent professionalism as their international counterparts.[11] 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 bank management.[4][6] Secondly, the committee
recommended GOI equity in nationalized banks be reduced to 33% for increased
autonomy.[4][12][13] 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 government equity.[11]
To implement this, criteria for autonomous status was identified by March 1999
(among other implementation measures) and 17 banks were considered eligible for
autonomy.[14] But some recommendations like reduction in Government's equity to
33%,[13][15] the issue of greater professionalism and independence of the board of
directors of public sector banks is still awaiting Government follow-through and

[edit]Reform in the role of RBI

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.[14][6] Second, the Committee proposed a segregation
of the roles of RBI as a regulator of banks and owner of bank.[17] 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 in order 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.[18] 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.

Stronger banking system

The Committee recommended for merger of large Indian banks to make them
strong enough for supporting international trade.[11] 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][11] This proposal had been severely criticized by the RBI
employees union.[20] The Committee recommended the use of mergers to build the
size and strength of operations for each bank.[12] 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 revitalize 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

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.[21] However, the recommended degree of
consolidation is still awaiting sufficient government impetus.[16]

[edit]Non-performing assets

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 build up of non-performing assets of the banks 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 build up 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][22][23] The option of recapitalization 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.[24][25][26]

[edit]Capital adequacy and tightening of provisioning norms

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.[9] This would also improve their risk taking ability.[11] 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.[14]

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.[27] The RBI
targeted to bring the capital adequacy ratio to 9% by March 2001.[28] 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.

[edit]Entry of Foreign Banks

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.

[edit]Implementation of recommendations

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.
[27] 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.[18][29][30] 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.[31]

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.
[20] 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 criticized 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.[32] 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 recapitalization 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 over the years.

Problems Identified By The Narasimham Committee

Directed Investment Programme : The committee objected to the system of

maintaining high liquid assets by commercial banks in the form of cash, gold and
unencumbered government securities. It is also known as the statutory liquidity
Ratio (SLR). In those days, in India, the SLR was as high as 38.5 percent. According
to the M. Narasimham's Committee it was one of the reasons for the poor
profitability of banks. Similarly, the Cash Reserve Ratio- (CRR) was as high as 15
percent. Taken together, banks needed to maintain 53.5 percent of their resources
idle with the RBI.

Directed Credit Programme : Since nationalization the government has encouraged

the lending to agriculture and small-scale industries at a confessional rate of
interest. It is known as the directed credit programme. The committee opined that
these sectors have matured and thus do not need such financial support. This
directed credit programme was successful from the government's point of view but
it affected commercial banks in a bad manner. Basically it deteriorated the quality
of loan, resulted in a shift from the security oriented loan to purpose oriented.
Banks were given a huge target of priority sector lending, etc. ultimately leading to
profit erosion of banks.

Interest Rate Structure : The committee found that the interest rate structure and
rate of interest in India are highly regulated and controlled by the government. They
also found that government used bank funds at a cheap rate under the SLR. At the
same time the government advocated the philosophy of subsidized lending to
certain sectors. The committee felt that there was no need for interest subsidy. It
made banks handicapped in terms of building main strength and expanding credit

Additional Suggestions : Committee also suggested that the determination of

interest rate should be on grounds of market forces. It further suggested minimizing
the slabs of interest.

Along with these major problem areas M. Narasimham's Committee also found
various inconsistencies regarding the banking system in India. In order to remove
them and make it more vibrant and efficient, it has given the following

Narasimham Committee Report I - 1991

The Narsimham Committee was set up in order to study the problems of the Indian
financial system and to suggest some recommendations for improvement in the
efficiency and productivity of the financial institution.

The committee has given the following major recommendations:-

Reduction in the SLR and CRR : The committee recommended the reduction of the
higher proportion of the Statutory Liquidity Ratio 'SLR' and the Cash Reserve Ratio
'CRR'. Both of these ratios were very high at that time. The SLR then was 38.5% and
CRR was 15%. This high amount of SLR and CRR meant locking the bank resources
for government uses. It was hindrance in the productivity of the bank thus the
committee recommended their gradual reduction. SLR was recommended to reduce
from 38.5% to 25% and CRR from 15% to 3 to 5%.

Phasing out Directed Credit Programme : In India, since nationalization, directed

credit programmes were adopted by the government. The committee
recommended phasing out of this programme. This programme compelled banks to
earmark then financial resources for the needy and poor sectors at confessional
rates of interest. It was reducing the profitability of banks and thus the committee
recommended the stopping of this programme.

Interest Rate Determination : The committee felt that the interest rates in India are
regulated and controlled by the authorities. The determination of the interest rate
should be on the grounds of market forces such as the demand for and the supply
of fund. Hence the committee recommended eliminating government controls on
interest rate and phasing out the concessional interest rates for the priority sector.

Structural Reorganizations of the Banking sector : The committee recommended

that the actual numbers of public sector banks need to be reduced. Three to four
big banks including SBI should be developed as international banks. Eight to Ten
Banks having nationwide presence should concentrate on the national and universal
banking services. Local banks should concentrate on region specific banking.
Regarding the RRBs (Regional Rural Banks), it recommended that they should focus
on agriculture and rural financing. They recommended that the government should
assure that henceforth there won't be any nationalization and private and foreign
banks should be allowed liberal entry in India.

Establishment of the ARF Tribunal : The proportion of bad debts and Non-performing
asset (NPA) of the public sector Banks and Development Financial Institute was very
alarming in those days. The committee recommended the establishment of an Asset
Reconstruction Fund (ARF). This fund will take over the proportion of the bad and
doubtful debts from the banks and financial institutes. It would help banks to get rid
of bad debts.

Removal of Dual control : Those days banks were under the dual control of the
Reserve Bank of India (RBI) and the Banking Division of the Ministry of Finance
(Government of India). The committee recommended the stepping of this system. It
considered and recommended that the RBI should be the only main agency to
regulate banking in India.

Banking Autonomy : The committee recommended that the public sector banks
should be free and autonomous. In order to pursue competitiveness and efficiency,
banks must enjoy autonomy so that they can reform the work culture and banking
technology upgradation will thus be easy.

Narasimham Committee Report II - 1998

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. The committee focused on various
areas such as capital adequacy, bank mergers, bank legislation, etc.

It submitted its report to the Government in April 1998 with the following

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 ration 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.

Apart from these major recommendations, the committee has also recommended
faster computerization, technology upgradation, training of staff, depoliticizing of
banks, professionalism in banking, reviewing bank recruitment, etc.

Evaluation of Narsimham Committee Reports

The Committee was first set up in 1991 under the chairmanship of Mr. M.
Narasimham who was 13th governor of RBI. Only a few of its recommendations
became banking reforms of India and others were not at all considered. Because of
this a second committee was again set up in 1998.

As far as recommendations regarding bank restructuring, management freedom,

strengthening the regulation are concerned, the RBI has to play a major role. If the
major recommendations of this committee are accepted, it will prove to be fruitful in
making Indian banks more profitable and efficient.